Investors who got burned by algorithmic stablecoins are scrambling to find the best alternative. Let's categorize and compare every stablecoin to help find the best one for you.
Updated Feb 27, 2023
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Stablecoins are one of the most useful tools for anyone investing in crypto. Prices of assets on the blockchain can be unstable, but stablecoins provide a hedge against volatility by maintaining the same value as assets in the real world like dollars or gold. Not only are they invaluable to crypto traders, but they provide a stable asset to people all over the world regardless of the monetary policy of their home country.
Anyone with a Web3 wallet and a little bit of crypto to pay for gas could, in theory, go bankless and start managing their assets on the blockchain—if only it were so simple. The reality is that not all stablecoins are created equal. Stablecoins vary significantly in terms of what's backing them, how they maintain their peg, and how much confidence they receive from the market. So, let's break down the list of stablecoins in 2023 and how to compare them.
Stablecoins are cryptocurrency tokens pegged to an external value such as a fiat currency or commodity. The safest stablecoins are secured by U.S dollars, but some of the best stablecoins are backed by the value of gold. Other stablecoins can be backed by collateral composed of other cryptocurrencies or can be backed by nothing at all and derive their value from an algorithmic minting mechanism—or are a hybrid of the two.
While USDC and USDT and most other popular stablecoins are issued by a central company or organization, decentralized stablecoins like DAI have also been able to successfully maintain their peg to the dollar. Confidence in any stablecoin comes down to the soundness of its underlying value mechanism, which is why frequent scrutiny is faced by companies like Tether, the world's biggest stablecoin issuer. Your goals as an investor and your risk tolerance are the biggest factors to consider when choosing a stablecoin to hold.
Stablecoin | Market Cap | Type | Target Asset | Price |
|---|---|---|---|---|
USDT | Fiat-backed | USD | ||
USDC | Fiat-backed | USD | ||
GUSD | Fiat-backed | USD | ||
XAUt | 459M | Commodity-backed | Gold | $1,861.14 |
PAXG | 622M | Commodity-backed | Gold | $1,865.16 |
DAI | Crypto-backed | USD | ||
FRAX | 1.478B | Algorithmic | USD | $1.00 |
*Data for XAUt, PAXG, and FRAX from CoinMarketCap on 6/3/22.
Fiat-backed stablecoins are tokens backed by fiat currency held in a bank. These stablecoins are centralized, meaning one entity is in charge of securing funds, minting tokens, and issuing them as stablecoins. The key to finding the best fiat-backed stablecoin is transparency, so the company issuing it must be accountable and frequently prove that they have enough money to back every stablecoin they issued.
Despite being the biggest stablecoin by market capitalization, USDT has been criticized for being insufficiently backed. Tether has admitted that their USDT stablecoin pegged to the US dollar is not fully backed by US dollars. The company—which also issues a Euro-based stablecoin called EURT—claims that the assets backing USDT include different forms of debt like commercial paper, U.S. Treasury bills, and government bonds.
While Tether does report its holdings to comply with transparency standards, there are some red flags when looking at Tether's fundamentals. Firstly, Tether has very little actual cash backing USDT since most of the assets backing the stablecoin are various forms of debt and other digital assets. Secondly, Tether's market capitalization recently dipped by over $10 billion in May 2022 after the stablecoin traded for as low as 95 cents. This shows that USDT could succumb to a potential bank run if the crypto market was to experience a serious crash.
Another common type of stablecoin is tokens backed by physical gold. Historically, gold is a good investment both as a store of value and a hedge against other investments. Buying gold-backed cryptocurrencies is one of the best ways to invest in gold since blockchain allows you to transfer assets instantly and with zero paperwork or jurisdictional limitations.
In addition to issuing fiat-backed stablecoins like USDT and EURT, Tether also issues a digital token backed by real gold called XAUT. Each XAUT token represents a fine troy ounce of gold and is backed by physical gold bars that meet the specifications of the London Bullion Market Association (LBMA). XAUT is issued exclusively on the Ethereum blockchain.
While the price of XAUT doesn't include a custody fee like most gold ETFs, there is a KYC process for anyone purchasing the tokens directly or redeeming them for gold. So, despite XAUT offering the permissionless transfer of gold-backed tokens on the blockchain, there are hurdles to cross for anyone looking to cash in the tokens in exchange for actual gold.
Another major stablecoin issuer is Paxos which in addition to issuing Pax Dollar (USDP) and Binance USD (BUSD) also created a gold-backed stablecoin called Pax Gold (PAXG). In a similar fashion to XAUT, each PAXG is an ERC-20 token representing a fine troy ounce of gold and is backed by LBMA gold bars, but there are a few differences. All of Paxos's gold is vaulted in facilities owned by The Brink's Company, a publicly-traded precious metals custodian.
Another thing that sets PAXG apart is the extremely low redemption fee offered by Paxos. While Tether charges a 0.25% fee on all XAUT redemptions, Paxos charges lower redemption fees based on the volume of gold being redeemed. Paxos's most competitive XAUT redemption rate is 0.03% but can be up to 1% if the amount being redeemed is relatively small. One downside PAXG shares with XAUT is that transferring either token requires an Ethereum gas fee, which can be costly when network traffic is high.
Crypto investors who are unsatisfied with the centralized nature of most stablecoins have opted to hold crypto-backed stablecoins instead. Crypto-backed stablecoins are tokens backed by collateral composed of other cryptocurrencies and they're a favorite amongst DeFi investors because anyone can create them through a decentralized minting mechanism. This usually involves depositing crypto into a smart contract which locks it up and issues a certain amount of stablecoins in return.
Multi-Collateral Dai (DAI) is one of the first decentralized stablecoins to ever be issued and each token is equal to one U.S. dollar. DAI is overcollateralized, which means each DAI token is backed by a combination of cryptocurrencies totaling a higher dollar value. In other words, each DAI is collateralized by more than a dollar worth of crypto, so the stablecoin will be sufficiently backed even if the value of the collateral goes down. This mechanism allows DAI to stay equal to one dollar while being decentralized.
Reliability and decentralization are what made DAI become so popular. DAI is sustained through an intricately designed ecosystem that balances minting mechanics with technical interests, economic incentives, and governance by a decentralized autonomous organization called MakerDAO. While anyone with enough crypto can use it as collateral to mint DAI, liquidation can be a risk if prices dip too low. Also, minting DAI is an inefficient use of capital since the amount of DAI you can mint must be lower than the actual dollar value of your collateral.
Stablecoins that aren't backed by anything are often called 'algorithmic' stablecoins, which can be a misleading term. Algorithmic stablecoins are tokens that combine a decentralized minting mechanism with economic incentives to help them maintain their peg to a target value, usually the US dollar. Hence, algorithmic stablecoins derive their value from a set of procedures that helps keep their value close to a set target.
Some algorithmic stablecoins are partially collateralized by other crypto assets while others are completely uncollateralized and derive their value solely from underlying mechanisms. Algorithmic stablecoins are more likely to diverge from their target value, and those that fluctuate frequently in price are often said to have a 'soft-peg,' meaning they will stay at approximately their target value but their price won't be as stable as a 'hard-pegged' stablecoin.
FRAX is a decentralized fractional-algorithmic stablecoin, which means that it's a hybrid between collateralized and algorithmic stablecoin. The FRAX token is issued by the Frax Protocol and each one is equal to one U.S. dollar. The Frax Protocol uses Frax Shares (FXS) as its governance token for voting on changes such as adding new collateral pools, adjusting collateral ratios, and changing minting or redeeming fees.
There are many things that make the FRAX stablecoin unique other than being the first hybrid algorithmic-collateralized stablecoin. First, FRAX uses USDC as its collateral asset, which means it partially relies on a centralized stablecoin to maintain its value. Second, the Frax Protocol governing FRAX's underlying mechanisms encourages simplicity and less active governance participation. This is in stark contrast to MakerDAO whose governors play a major role in determining the parameters of DAI's underlying mechanisms.
Whereas most algorithmic stablecoins are cautionary tales in the grand scheme of crypto, FRAX is an exception. Algorithmic stablecoins are difficult to sustain because they're hard to bootstrap (configure to existing markets), are slow to grow, and can experience extreme volatility which undermines confidence people have in them. Contrary to that, algorithmic stablecoins that grow too fast can become too large to sustain, causing them to collapse and inflict collateral damage on other assets. The demise of the Terra blockchain and its UST stablecoin is a prime example of that.