Having 100% collateral in the same currency and with a price obtained via trades is the most commonly used way to achieve parity of a Stablecoin with fiat currency.
In this model, the proposal is that the collateral – or backing, if you prefer – must at least be equivalent to the value of the tokens issued. If we have USD 100,000 as backing for this Stablecoin, we can only issue a maximum of 100,000 tokens. Thus, the idea is that if someone wishes to sell the tokens for USD, they will be able to receive at least the corresponding value, ensuring the 1:1 parity of the token with USD. If there is more collateral than tokens issued, this can even be perceived as an advantage, but it all depends on the nature of the collateral.
For example, if the collateral is in dollars in a checking account and we have USD 100,000 in one account, with only 50,000 tokens issued, theoretically (and very likely in practice) this token would be traded at 2:1, that is, USD 2.00 for each token. This is not the goal of the Stablecoin issuer, who seeks a ratio as close to 1:1 as possible. The most well-known example of this type of Stablecoin is Tether (USDT). Created in 2014, USDT is a token backed by the dollar and currently has a market value of approximately USD 80 billion, making it the third largest crypto by this measure, surpassed only by Bitcoin and Ether.
The value of Tether in dollars aims for parity (1.00 USD / 1.00 Tether), given that, conceptually, for every Tether issued, there is the same amount of dollars in a vault, but if we look at the price history, we see that this relationship is not as stable as one would expect. This occurred, largely due to doubts raised regarding the amount of dollars held not being the same as the Tethers issued, and the difficulty they had in demonstrating this.
Tether was a Stablecoin widely used by Bitfinex, which was one of the major crypto exchanges from 2016 to 2018, and the connection between the two goes beyond that. Some reports place Bitfinex as one of the companies behind its creation, which is not entirely surprising. All cryptocurrency exchanges in the world have faced difficulties with accounts in traditional banks at some point, and having a Stablecoin backed by dollars makes it easier not to use the traditional banking system to settle adjustments between internal accounts, in addition to doing so more quickly, transparently, and audibly from the company's internal perspective.
Much has been speculated – and continues to be speculated – about Tether's ability to prove that it has sufficient backing to honor its commitments, should 100% of USDT holders want to exchange them for USD. In recent years, there has been a clear movement by Tether toward greater transparency in this regard. As for what is on the Blockchain, we can easily verify. The challenge is understanding the part related to the traditional financial market, and it is at this point that attention has been focused. Through the release of periodic reports, audits, and other measures, efforts have been made to seek greater transparency in both aspects: what is on the Blockchain and what belongs to the traditional financial market.
At the moment I am writing this book, I notice that USDT has withstood the setbacks faced by UST in May 2022 and the volatility experienced by USDC in the first half of 2023, due to the percentage of USDC reserves held at Silicon Valley Bank. USDT is regaining its position as one of the leading Stablecoins in the Blockchain market, having reached, in early 2024, the mark of 100 billion UsDTs issued.
The second most prominent and used Stablecoin in the market is USDC, issued by the exchange Circle, which has participation from Coinbase. Until the beginning of 2023, many believed it was the safest and most protected among all Stablecoins, as it belonged to a company under the supervision of the American regulator. However, this perception was shaken by the incident involving Silicon Valley Bank (SVB).
SVB, the sixteenth largest American bank, needed to be rescued by the FIDC (analogous to our FGC in Brazil). The bank faced difficulties meeting withdrawal demands from its clients, as it had invested in low-liquidity assets or accounted for them in a way that did not allow for immediate access. A bank run resulted in withdrawals of USD 40 billion in a single day, leading the bank to close its doors the following Friday. This generated great concern among its clients, among whom was Circle, the manager of USDC.
Approximately 6% of the deposits backing USDC were deposited at SVB. In the event of the bank's bankruptcy, Circle would only be entitled to the amount guaranteed by the FGC, which is USD 250,000. On the Sunday following the incident, Circle made a statement, assuring that, regardless of the outcome with SVB, USDC's parity would be ensured by its own capital. It stated that there was no reason for concern. However, the token was traded at USD 0.90. After this episode, there was a decline in the amount of USDC issued, which at the time of writing is at 30 billion, recovering from 25 billion at the end of 2023.
The list of Stablecoins pegged to the dollar, through the mechanism of total collateralization of the underlying asset, continues with Tusd (TrueUSD). Its purpose is to convert people's dollars into cryptocurrency. For Tusd to be issued, any individual can send dollars to one of the partner institutions. These amounts are then deposited in an Escrow Account (a type of account where the funds remain blocked until certain conditions are met; in this case, the elimination of the tokens issued backed by that money). Thus, the company is allowed to issue Tusd tokens on behalf of the depositor. The main goal is to offer a service that allows everyone to have access to dollars in the digital environment, facilitating their transactions. We also have Busd (BinanceUSD), managed by the Binance Exchange, one of the largest in the world, which announced that it should support it only until early 2024, a decision aligned with the fact that Paxos, the company responsible for coordinating the entire BUSD mechanism, will not allow redemptions after this period.
Paxos, in fact, has its own Stablecoin, USDP, which, among other innovations, has the issuance of the token being carried out by an institution regulated by the New York State Department of Financial Services in the United States – the same regulator that created the controversial Crypto License (Bitstamp) for crypto companies in New York.
Indeed, it is the regulatory issues that are at the heart of this decision to discontinue BUSD.
Gemini, a company created by the Winklevoss twins, has the Gemini Dollar (GUSD), with the same market proposal as Tether, that is, to have each Gemini Dollar directly pegged to 1 dollar in custody, but with a new way of verification and independence between issuer and custodian, aiming to bring more trust.
The list of Stablecoins backed 100% by a fiat currency is not limited to those mentioned, and every week there is a new initiative to create a Stablecoin pegged to the dollar, or other fiat currencies, that aims to make this transition from the 'traditional' currency world to the Blockchain world in a safer, faster, and more transparent way.
We also have initiatives for the issuance of private-backed Stablecoins such as JPMcoin from JP Morgan, which is a Stablecoin backed 1:1 with the US dollar and has been tested by the bank for transfers between institutional accounts, initially bringing advantages to the bank such as making internal value transfer processes faster, more transparent, and auditable.
More recently, we had Paypal launching its dollar Stablecoin, PyUSD, in partnership with Paxos, which, in principle, will only be used on the Paypal platform but is already born with the intention of taking bigger flights and being traded outside the platform as well.
Anchoring to a backing is a way to gain trust and credibility for a currency and has already been used by notes issued by governments (fiat currency) which in their early days were backed by gold. History shows that, at a certain point, trust in these currencies became so great that the need for a backing was no longer necessary. In the case of the dollar, this happened after the United States broke the Bretton Woods agreement in 1971, as we saw in the first chapter.
Regarding Stablecoins, how much time will we need for them to gain trust and no longer require backing? This is a question that, despite being on the radar of regulators and Central Banks – who were obviously observing this movement – was ignored given the size of the market, back in 2018. Until a giant player, at the time Facebook, now Meta, decided to embark on this path.