Stablecoins, especially fiat-backed stablecoins, seem poised to dominate online currency exchanges across the world. Tether grew by approximately 82 billion USD in five years and USD coin by approximately 54 billion USD in two years. How did this happen? What is the history of stablecoins?
In a word, brief. In several words: expansive, incredible, awe-inspiring, somewhat confusing.
This article follows the history of stablecoins from its first origination only five years after Satoshi Nakamoto’s Bitcoin, 2014, through to today. In other words, this article describes the creation of hundreds of billions of market capitalization of a new asset class in eight years.
The world’s first stablecoin was released on July 21, 2014. As a crypto-backed stablecoin, BitUSD was issued on the BitShares blockchain, which is now mired in obscurity.
Dan Larimer (EOS) and Charles Hoskinson (Cardano) envisioned these pioneering digital assets before they went on to become cryptocurrency rockstars today.
However, BitUSD lost its 1 to 1 parity with the US dollar in 2018 and has been unable to recover since. BitMEX’s research brilliantly highlighted the stablecoin’s weakness in their detailed analysis of BitUSD. BitUSD was collateralized with an obscure, volatile, itself-unbacked asset, BitShares.
In the event of a fall in the price of BitShares, a single BitUSD can be used to purchase more of Bitshares and thereby encourage mass arbitrage similar to traders of traditional asset classes. However, the opposite was not guaranteed. There was only an implied pile of reserves from BitShares alone. Therefore, BitUSD operated much more like a volatile security than a stablecoin.
Yet it did succeed in putting the concept of pegged stablecoins on the radar and beginning the history of stablecoins.
Also launched in 2014, the second stablecoin provided ample lessons to the fledgling, but growing crypto community. NuBits was crypto-collateralized, similar to BitUSD, but this time using Bitcoin.
Ultimately, that failed to help in any way. Since Bitcoin was and is a volatile asset trading according to the tune of speculators across the world, Nubits reserves could not be high enough nor mature enough to withstand a rout. As Bitcoin fell, the coin’s reserves fell.
Like with traditional investing, the primary method to reduce the impact of volatility is to diversify. However, not only were the reserves of NuBits fairly volatile, they were insufficient and undiversified.
A lack of capital and diversification spelled doom for the second stablecoin, now trading around 0.04 USD.
In May 2022, the TerraUSD (UST) algorithmic stablecoin crashed, hard, losing almost all of its value in days.
TerraUSD relied upon an algorithm and the forces of arbitrage to fix the value of one UST to one US dollar. If it became too cheap, the (centralized) powers behind UST could retract supply or provide further incentives for holders of other cryptocurrencies to convert their holdings into UST coins. If it became too expensive, additional supply could be created.
However, demand would remain naturally occurring, even if incentivized. This translated into a glaring weakness.
Despite the Luna Foundation Guard, the body protecting TerraUSD’s reserves, once holding a warchest of over 70 thousand bitcoins, it failed to prop up the stablecoin in the face of a complete rout. Today, one UST is roughly 0.02 USD.
In the history of stablecoins, all three carry one essential lesson: unstable cannot back stable. In normal market circumstances, partial reserves and arbitrage mechanics probably do the job just fine in the context of fractional reserve banking. As long as all investors do not act all at once, a non-fiat-backed stablecoin should function normally.
This is why the headlines covering each of these three crashes also carry the same tone of: fine, until not fine. In each instance, too many investors piled into the selloffs and effectively broke the reserve assets.
Unless there is a 100%, stable reserve backing a so-called stablecoin, most investors feel weary of the street logic. Meaning, how can an idea of assumed stability or enough volatile reserves become enough to handle a total rout? It can’t. That’s all there’s to it.
Launched in 2014, Tether (USDT) came to extraordinary success with a current market capitalization exceeding 67 billion USD.
This stablecoin fixes the issues inherent in the previous three. It relies not upon volatile reserves or the idea of persistent arbitrage trading, but on hard reserves of fiat currency. For every Tether coin in existence, there is one US dollar in a vault backing its existence.
In this way, the stablecoin handles a complete theoretical rout with ease. Tether continues to serve the burgeoning digital asset space while garnering the implicit affection of regulators.
Launched in 2017, MakerDAO’s Dai is a decentralized, crypto-backed stablecoin capturing the hearts of DeFi (decentralized finance) investors.
The match in ethos feels all well and good, but is Dai secure? Is it at risk because of its crypto-backed nature?
Dai has yet to crash or break its 1 to 1 peg to the US dollar. The stablecoin is technically a hybrid of crypto-backed and algorithmic, employing a simple algorithm requiring 1.70 USD worth of Ethereum to be deposited in exchange for any 1.00 Dai.
The premise here remains simple and that is a very good thing in terms of handling potential crashes. MakerDAO is banking on (1) a 70% buffer in value and (2) diversified reserves. In addition to Ethereum, the stablecoin utilizes USD Coin (like Tether; 42% of reserves) and Wrapped Bitcoin amongst others.
And in these holdings we see a third, albeit clever safety mechanism. Approximately half of Dai’s reserves are fiat-backed through fiat-backed stablecoins.
The history of stablecoins remains brief, but exceptional. In that time, entrepreneurs daring to transfer the global landscape of financial services learned key lessons.
BitUSD, NuBits, and TerraUSD failed due to an overreliance upon a volatile asset backing an intentionally stable asset. Volatility without diversification struggled under the weight of investor redemptions–something any bank could potentially encounter. The growing Dai stablecoin continues to succeed due to its steep algorithmic requirements and diversity in reserves.
Tether and USD Coin function remarkably well despite a “crypto winter” and leave regulators in begrudging awe of their efficacy. In eight years, stablecoins stand ready to disrupt traditional financial services on a global scale.
Disclaimer: The author of this text, Jean Chalopin, is a global business leader with a background encompassing banking, biotech, and entertainment. Mr. Chalopin is Chairman of Deltec International Group, www.deltecbank.com.
The co-author of this text, Conor Scott, CFA, has been active in the wealth management industry since 2012, continuously researching the latest developments affecting portfolio management and cryptocurrency. Mr. Scott is a Freelance Writer for Deltec International Group, www.deltecbank.com.
The views, thoughts, and opinions expressed in this text are solely the views of the authors, and do not necessarily reflect those of Deltec International Group, its subsidiaries, and/or its employees. This information should not be interpreted as an endorsement of cryptocurrency or any specific provider, service, or offering. It is not a recommendation to trade.