How Stable are Stablecoins?

Let's talk about stablecoins.

Stablecoins are cryptocurrencies in which the prices are pegged to fiat currencies or other cryptocurrencies and in some instances to metals particularly gold. The primary purpose and use of stablecoins are as stores of value for users to secure their gains in the highly volatile crypto space.

Stablecoins could be divided into three to four types depending on whom you will ask. However, for better classification, I will be using four.

The first type of stablecoins are those which are backed by fiat currencies, properties and commercial documents as collaterals. This type of stablecoins is the most dominant in the crypto space. Tether USDT, USD Coin USDC and Binance USD BUSD fall within this classification.

The second type of stablecoins are those which are backed by commodities as collaterals. Gold is by far the most used asset to collateralize this type of stablecoins. Pax Gold PAXG which is pegged to gold fall within this classification.

The third type of stablecoins are those which are backed by another cryptocurrency as collaterals. DAI which is built on Ethereum and governed by the MakerDAO system and EOSDT which is backed by EOS fall within this classification.

The last type of stablecoins are algorithmic stablecoins which uses algorithms to balance the circulating supply of the asset. In simple terms, the algorithm issues more coins when price increases, and buys them off the market when the price falls. Ampleforth AMPL falls within this category.

There are also stablecoins which are backed by crypto but also uses algorithms to balance it supply. One notable example is TerraUSD UST is which is collateralized by Luna, the native token of the Terra blockchain. The Terra protocol acts as a market maker for the stablecoin. If the stablecoin system runs out of assets, it restocks by inflating the native LUNA supply.

Stablecoins can also be classified between centralized and decentralized stablecoins.

Stablecoins backed by fiat and commodities are centralized which means that a single authority is in full control of the minting and deciding who could use the minted stablecoins. The biggest stablecoins right now which are USDT, USDC and BUSD are all centralized. On the other hand, most of crypto-backed stablecoins and all currently existing algorithmic stablecoins are decentralized which means that no single entity or authority is in full control.

The main criticism against fiat-backed stablecoins are centralization and lack of transparency as to whether backed by sufficient and liquid fiat or not. On the other hand, the main contention against crypto-backed stablecoins is the need for more assets as reserve to keep the system secure and algorithmic stablecoins are being criticized heavily for not really being backed by actual fiat and other assets.

What type of stablecoins are you comfortable to use as a store of value for your gains?