One of the world’s largest asset managers projects that the stablecoin market will tip $3 trillion in the next four years, a 22x leap from today. This, according to an update shared by Ripple Labs.
Putting this adoption in context “requires understanding the role stablecoins play in financial markets, including their utility, use cases, and how their blockchain properties push financial services innovation.”
As explained in a blog post by Ripple Labs, a stablecoin is described as “a private-issued digital asset pegged to the value of a fiat currency or commodity, such as USD, EUR, or gold.”
Stablecoins may be pegged to multiple asset values “as well, and provide ‘stable’ value over time by tracking the value of the underlying asset.”
The primary aim of stablecoins is “to combine the instant processing and security of cryptocurrency transactions with the steady value of traditional currencies or assets. While stability is the goal, it is not guaranteed nor without risk.”
In the past, some stablecoin projects “have de-pegged from their underlying assets.”
Still, stablecoins can “offer security, immediate payment processing, price stability due to backing by fiat currency reserves or other assets, and enable private transactions.”
Ripple Labs also mentioned that stablecoins exist “most commonly in three varieties, differing based on their mechanisms for maintaining stability.”
These include:
- Fiat-Collateralized Stablecoins
- Crypto-Collateralized Stablecoins
- Algorithmic Stablecoins (Non-Collateralized)
Fiat-Collateralized Stablecoins
These stablecoins are backed by “a reserve of fiat currency at a 1:1 ratio. For each stablecoin issued, an equivalent amount of fiat currency is held in reserve.”
This direct backing by fiat currencies, “alongside an ability to be redeemed for the fiat currency equivalent, promotes stability and helps ensure that the value of the stablecoin remains constant. Popular issuers include Circle (USD Coin or USDC) and Tether (USDT), with others like Paypal USD (PYUSD) coming onto the scene more recently.”
These types of asset-backed stablecoins “maintain their stability by holding reserves of fiat currencies or other financial assets.”
Crypto-Collateralized Stablecoins
These stablecoins are backed “by other cryptocurrencies.”
Since the reserve cryptocurrency may also be volatile, such stablecoins often “over-collateralize”, meaning they hold “a larger amount of the reserve asset than the stablecoin issued to account for value fluctuations. In some cases, stablecoins can be overcollateralized with ratios up to 200%.”
These stablecoins may rely “on mechanisms like smart contracts to maintain their peg, including algorithms that automatically manage coin supply in response to demand shifts or the value of the collateral.”
A notable example is DAI, by MakerDAO, an Ethereum-based protocol which “is pegged to the US dollar, but backed by Ethereum and other cryptocurrencies.”
Algorithmic (Non-Collateralized) Stablecoins
Purely algorithmic stablecoins, sometimes referred to “as unbacked crypto assets, are not backed by any actual assets. As such, this variety relies on a working mechanism based on algorithms and programmable smart contracts to maintain their peg.”
To ensure stability, an algorithm automatically “manipulates the supply of the stablecoin in response to demand shifts. Notable examples by market capitalization include USDD and USDX.”
Each version offers various utility “across the financial system and supports use cases ranging from daily transactions to complex financial operations. In many cases, stablecoins can create a bridge between cryptocurrencies and predictable value needed for everyday use in traditional finance and beyond.”
The update from Ripple Labs also noted that Central Bank Digital Currencies (CBDCs) and stablecoins are “both forms of digital currency, but they differ significantly in their backing, issuance, and intended use.”
CBDCs are digital currencies issued and “governed by a nation’s central bank, making them a digital form of a country’s existing fiat currency. Because they are backed by the government, they maintain legal tender status in the issuing country.”
A primary goal of CBDCs is to improve “the efficiency of the payment systems, enhance financial inclusion, and maintain the sovereignty of national currencies. While stablecoins represent the fiat dollar issued by a central bank, CBDCs are the digital dollar.”
According to the World Economic Forum, reasons countries are exploring CBDCs include preventing the “fragmentation of the payment landscape into CBDCs, stablecoins and private crypto assets.”
Differences between these two asset types are:
- Issuer type (central banks vs. private entities)
- Backing and stability mechanisms (government-backed vs. asset- or algorithm-backed)
- Regulatory frameworks (extension of a fiat currency vs. decentralized, between crypto market participants.)
The Ripple Labs report concluded:
“Across the global financial ecosystem, the future looks bright. New value form factors like stablecoins and CBDCs mean advances ranging from cashless payments and new consumer products, to transaction settlement, market interoperability, and simplified financial operations. While infrastructure and adoption must still grow, the future state of frictionless value-exchange is nearer now than ever before.”
