What Are Stablecoins?
Stablecoins are a class of cryptographic money whose value is pegged to an underlying relatively stable asset, a fiat currency (eg, the US dollar, gold) or other cryptocurrency. Stablecoins, by virtue of their claim to relative stability, are designed to be used for everyday transactions, to be held as savings, and for DeFi applications.
The Importance of Stablecoins in DeFi
DeFi – short for Decentralised Finance – is the decentralised, peer-to-peer finance system enabled by various decentralised technologies built on the Ethereum blockchain, and the financial services (lending, borrowing, trading) that they make possible. DeFi functions without any central authority. Stablecoins reduce the risk of high volatility that comes with regular cryptocurrencies.
How Stablecoins Enhance DeFi Applications
Stablecoins have some critical advantages crucial to DeFi applications. They provide a means of exchange with a stable value, making transactions more certain. For any lending platform or a platform providing any kind of collateralisation for loans, the value of collateral must be relatively stable over time. Because slippage is a significant risk for trading on decentralised exchanges (DEXs), stablecoins provide a smoother and more efficient trading experience.
Examples of Stablecoins in DeFi
Several stablecoins are central to DeFi. The three largest are Tether (USDT), USD Coin (USDC) and Dai (DAI). The former two are ‘hard-pegged’ to the US dollar and backed by reserves of dollars in the traditional banking system, while the latter is ‘soft-pegged’ to the US dollar, backed by collateralised crypto assets instead of fiat currency. This is a more decentralised form.
Risks and Considerations
While useful, stablecoins come with a level of risk to bear in mind, such as the liability of the collateralisation mechanism and the reliability of the reserve audits. For example, fully-backed fiat stablecoins rely on the integrity of the issuer, and the security of the reserves that the token stands as a claim on. On the other hand, crypto-collateralised stablecoins such as Dai are exposed to the volatility of the assets undergirding the coins.
The Future of Stablecoins in DeFi
The incorporation of stablecoins into DeFi is set to increase further as these tools act as a conduit between traditional finance and decentralised networks. Further innovation in the technology behind stablecoins and a more comprehensive regulatory regime could enable more robust versions of these tools, strengthening their utility and trustworthiness and widening their uptake in DeFi.
In conclusion, stablecoins underpin the current DeFi ecosystem and, with these foundations, DeFi can grow further to become a trusted financial service for all.
