Analysis of Stablecoins: Definition, Classification, and Their Role in the Crypto Assets Ecosystem

Stablecoins play an important role in the Crypto Assets industry. As of July 25, 2024, the market capitalization of stablecoins is approximately $165 billion, accounting for nearly 7% of the total Crypto Assets market of $2.417 trillion. Among them, Tether (USDT) is currently the third-largest Crypto Asset by market capitalization, only behind Bitcoin and Ethereum.

This article will delve into the definition, classification, and importance of stablecoins in the field of digital currencies. We will also explore the operating mechanism, potential risks, and development prospects of USDe through a case study of Ethena USDe.

Definition of Stablecoin

According to the definitions of the Financial Stability Board and the Bank for International Settlements, a stablecoin is "a Crypto Asset designed to maintain a stable value relative to a specific asset or a group of assets." Typically, stablecoins are pegged to fiat currencies like the US dollar.

The Necessity of Stablecoins

In the context of the large-scale application of Web3, stablecoins have the following advantages:

1. Compared to traditional assets, digital assets offer more convenient tradability. Stablecoins, as a medium of exchange with stable value, facilitate daily transactions while enabling fast and low-cost cross-border payments.

2. Compared to other Crypto Assets, stablecoins help mitigate the impact of value fluctuations. During periods of market volatility, stablecoins provide a unique value stability, becoming a safe haven for value preservation.

Classification of stablecoins

Stablecoins are mainly divided into two categories: collateralized stablecoins and algorithmic stablecoins.

collateral stablecoin

Collateralized stablecoins are fully backed by other assets, ensuring their value is supported by the collateral. Mainly includes:

1. Fiat-backed stablecoins: Supported by reserves of fiat currency, such as USDT and USDC.
2. Commodity-backed stablecoin: Supported by commodity reserves, such as Tether Gold (XAUt).
3. Crypto Assets collateralized stablecoins: supported by reserves of other Crypto Assets, such as DAI.

algorithm stablecoin

Algorithmic stablecoins ensure the security of collateral or adjust market circulation to maintain stability through algorithms. The main methods include:

1. Clearing mechanism: By auctioning off risk collateral, ensuring that stablecoin debts are fully collateralized.
2. Destruction and Minting: Maintain price stability by adjusting the total supply.
3. Adjusting the lending rate: Control the supply of stablecoins by changing the lending rate.

It is worth noting that these classification methods are not mutually exclusive; stablecoins can adopt multiple mechanisms to maintain stability.

Security Risks and Solutions of Stablecoins

1. Collateral Transparency: Enhance transparency through third-party custody, regular audits, and the publication of reserve proof reports.

2. Collateral value volatility: Implement an over-collateralization and liquidation mechanism to mitigate the potential negative impacts caused by value fluctuations.

3. Smart contract vulnerabilities: Conduct rigorous security audits and continuous security monitoring.

4. Market Volatility: Design flexible stable mechanisms to enhance liquidity and ensure the accuracy of oracle data.

Mainstream stablecoin analysis

According to DefiLlama data, the top 20 stablecoins account for over 99% of the total market capitalization. Among them, the top 5 stablecoins (USDT, USDC, DAI, USDe, and FDUSD) account for 96% of the total market capitalization. This indicates that the market is dominated by a few key players.

Among the top 20 stablecoins, all stablecoins are backed by certain assets, with 9 also incorporating algorithmic stabilization mechanisms. This phenomenon indicates that, despite the claims of algorithmic stablecoins regarding their excellent stabilization mechanism design, users show a clear preference for fully collateralized stablecoins, especially those backed by fiat currency.

USDe Case Study of Ethena Labs

USDe is a stablecoin issued by Ethena Labs and has currently become the fourth largest stablecoin by market capitalization. The design principle of USDe is mainly based on the stability mechanism of centralized exchanges (CEX), using a "delta hedging" strategy to maintain the stability of the collateral assets.

The returns of USDe mainly come from two parts: the native yield from ETH staking and the returns from delta-hedged derivatives positions. The latter includes funding rate income and basis spread income.

However, USDe also faces some potential risks:

1. Centralized Risk: Dependence on CEX may become a vulnerability in the system.

2. Market Risk: A sustained negative funding rate may cause certain parts of the yield design to turn negative.

Conclusion

Stablecoins play an important role in the Crypto Assets ecosystem, providing stability to the market and facilitating transactions. Different types of stablecoins meet various needs of the crypto community, but there are also risks such as collateral transparency, value fluctuations, and smart contract vulnerabilities.

As Ethena Labs continues to improve USDe, a key question is whether USDe can maintain stability amid market fluctuations and avoid a collapse similar to Luna. Although the underlying assets and economic model of USDe are designed differently from Luna, its stability and market performance still require close attention.

Given the importance and potential risks of stablecoin, continuous security audits and monitoring are crucial for maintaining market stability and trust.