Understanding Stablecoins — USDT, USDC, BUSD, UST, DAI

Simply put, a stablecoin is a cryptocurrency that is backed by a stable asset. In most cases, this stable asset will either be the dollar, euro or equivalent (cash) value, gold or another commodity, or it will represent a combination of currencies.

The reasoning behind stablecoins is to provide traders and companies an option to keep their currency on the blockchain without worrying about the risk of losing significant value overnight (which regularly happens with Bitcoin or Ethereum).

How Do Stablecoins Work? The issuer guarantees that for every token issued, one dollar (or equivalent) will be in a bank as collateral, or the peg is regulated by an algorithm. If the value of the token is below $1 (or equivalent), or if the value of the token goes above $1 (or equivalent), then an arbitrage transaction will take place. For example: Someone can buy 1 token for $0.99, and sell it to someone for $1.00, thus returning stability back into the market.

As of 2024, the total market capitalization of the stablecoin market exceeded $167 billion, with USDT capturing approximately 67% share. As a whole, the stablecoin market provides much-needed utility and stability in an otherwise chaotic Cryptocurrency market.

"Total stablecoin market cap as of 2024 exceeded $167 billion, approximately 67% of that market share was with USDT" - (source: CoinGecko 2024).

The two main functions of stablecoins are:

• To Lock in Profit, E.G. if Bitcoin value has increased from $30,000 to $47,000 you can transfer your profits to USDT, and leave them on the blockchain until you withdraw them to a bank account.
• To Provide Liquidity to DeFi (Decentralized Finance) Platforms, stablecoins are used by DeFi to fund lending, farming, and staking platforms. Without stablecoins, decentralised finance (DeFi) would be in chaos and would resemble a casino or betting business but at such huge stakes.

International Payments: Many organisations in countries that have issues with traditional banking systems (e.g., Russia, Latin America, and Africa) are often forced to use the USDT to bypass high-tier commissions associated with international transfers; the commissions are typically between 3% and 7%.

Typically, stablecoins help make international payments simpler, quicker, and less expensive.

Stablecoins make international transfers simpler for organisations in countries with conventional banking systems under sanctions by reducing the commission and the time required to complete the transfer. Chainalysis (2023)

The defining characteristic that separates stablecoins from traditional cryptocurrencies is their relationship to an outside asset. Cryptocurrencies such as Bitcoin are designed to function independently of any fiat currency such as the US dollar; however, stablecoins simulate the stability of a fiat currency. Although valuing stablecoins based on the underlying currency is convenient, if the coin's peg were to break (i.e., UST in May of 2022), the value of the coin could theoretically drop to zero.

The stablecoin marketplace is not in equilibrium. The largest stable coin in the market, Tether (USDT), constitutes 65% of the entire market, while the next largest, Circle (USDC), represents only 21% of the total marketplace. Other stablecoins serve to differentiate themselves by establishing a track-record of sustainability within their coins, maintaining an audit of the reserves backing their coins, and developing a transparent corporate governance model behind their projects.

During the Blockchain Life 2024 Conference in Dubai, I talked with numerous Asian entrepreneurs (founders of DeFi protocols) and all of them overwhelmingly preferred Tether (USDT). Why Tether? They all reported that the reason was liquidity; USDT is the most widely circulated stablecoin and has multiple uses in nearly every country around the globe; USDT has never lost its dollar peg and has been unfairly characterised by some as non-transparent regarding the reserves backing USDT.

Ultimately, stablecoins represent the financial underpinnings of the broader crypto economy: arbitrage is impossible without the use of stablecoins, DeFi cannot operate effectively without using stablecoins, and international payments cannot take place without the use of stablecoins. Centralized and decentralised options have tradeoffs regarding risk, liquidity and transparency due to the different forms of regulation.

Stablecoins will solve the problems of extreme volatility in crypto currencies by providing stability to maintain the purchasing power of the US dollar.

Stablecoins will provide immediate and fast payment options as the average time for transaction through USDT (Tether) is between one (1) to ten (10) minutes (depending on the blockchain) while traditional banking transactions through the SWIFT system often take several days to process. For businesses, this time difference is significant.

Stablecoins have very low commissions compared to huge transfer fees in traditional banks (i.e., the cost to send $10,000 of USDC via Ethereum is approximately $2.00-$5.00 but the charge from a bank would be approximately $25.00-$50.00 for a similar transaction).

Stablecoins offer the convenience of a 24/7 payment system, meaning anytime of day you will receive a payment within that 24-hour period. For example, if you receive a payment from an Australian company on Friday evening at 11 PM (Moscow time), you receive that payment immediately without having to wait for businesses to reopen on Monday.

After the implementation of sanctions (i.e., Russian banks being prohibited from using the SWIFT system after the start of the Ukraine war in early 2022), USDT is one viable alternative for making payments of goods and services for companies in South East Asia, the Middle East, and Latin America.

Arbitrage is one method of generating profits through the use of stablecoins by identifying the price of stablecoins between different exchanges. For example, if the price of USDT on the Binance global exchange is $1.00 and on a local exchange it is $1.02, you could buy USDT from Binance at $1.00 and resell it at $1.02 on the local exchange generating a 2% profit on the USDT transaction. ASCN has developed a way to automate this monitoring of USDT arbitrage opportunities and help identify these trades when the price spreads are at appropriate levels for our clients to close.

Stablecoins have many uses, including:

• Being used to buy goods and services (as in, exchanging BTC/USDT or ETH/USDC);
• Acting as collateral in DeFi platforms for loans, farming, or staking;
• Providing a means to hedge (you can realize profits when you sell BTC without triggering taxable events).

Stablecoins do not necessarily eliminate all of the risks associated with cryptocurrencies; instead, they redistribute the original risks to a third party. Centralized stablecoins such as USDT or USDC rely on the banking system and can be frozen at the bank's discretion. In contrast, DAI, a decentralized stablecoin, is also susceptible to the underlying collateral depreciating in value, which would create a scenario where it loses tie to the US dollar.

An example demonstrating this occurred during the October 11, 2024 flash crash when the price of BTC fell from $63K to $58K in under one hour. The price of USDT on Binance versus the price on local P2P exchanges was 5% - 7% apart at that time. Users of ASCN.AI received alerts from an AI assistant and successfully profited from the arbitrage opportunity before anyone was able to perform manual monitoring.

The days of manually watching the market are over. With AI-powered automation, arbitrage opportunities will close faster than you can check the data.

Types of Stablecoins - Features

There are three categories of stablecoin based on how their price is backed: fiat-backed, crypto-backed, and algorithmic. Each has some advantages and disadvantages associated with them.

Fiat-Backed Stablecoins - Examples: USDT, USDC, BUSD

Fiat-backed stablecoins are issued based on a 1:1 ratio, meaning for every US dollar in the reserve held by the issuer, they issue 1 stablecoin (for example, Tether claims that 85% - or something like 50B USDT - of their reserves are in cash or US government securities, with the remainder being corporate bonds or other loans). When someone wants cash, it can be obtained directly from an issuer, meaning there is no reason for a holder of USDT to believe they would not be able to convert their USDT into fiat at any time by asking for it.

Monthly audits conducted by Circle with USDC confirm reserve capacity for USDC, ensuring the existence of reserves under USDC. USDC exemplifies transparency because its reserve audits are publicly available and USDT's reserve audits are ambiguous; thus, USDT is continuously criticized.

USDT is issued from the British Virgin Islands and USDC is issued from Circle and Coinbase in the United States, while BUSD is issued from Binance/Paxos in the US (however, BUSD issuance was suspended by regulatory authorities because the regulatory restrictions were placed on BUSD after the calendar year of 2023).

Reasons traders prefer using USDC, USDT and/or BUSD:

• Simple and clear: You can cash-in at the bank for the dollar amount of the digital token you hold (dollar=b=token).
• Huge liquidity: You can convert the digital tokens into cash or pay for goods and services using those digital tokens at almost all businesses.
• Fast, simple process to convert digital token into cash or pay for goods/services using digital tokens through partner bank.

Reasons to remember about risks of using USDC, USDT and/or BUSD:

• Centralized: If law enforcement makes a request to (the issuer), they (the issuer) will freeze your digital tokens without notifying you ahead of time (i.e., Tether has done this).
• Bank Dependency: If Tether's account is frozen or it's having banking issues, the liquidity of your digital tokens decreases.
• Regulatory Issues: BUSD was fully withdrawn from circulation during calendar year 2023 due to regulatory issues faced by the issuer.

For example, in 2021 New York state fined Tether $18.5 million for hiding material information regarding the state of its reserve funds; the actual funds were secured by loans that Tether had extended to its affiliated companies from 2017 through 2019.

"The NY AG found that Tether existed loans to affiliates rather than cash to back the value that Tether purported to have in liquid reserve" - NAG (2021).

USDC had approximately $3.3 billion of its total reserve funds stored in Silicon Valley Bank (SVB) when the bank suddenly failed in March 2023 and subsequently, the value of each USDC token dropped to $0.88 but quickly recovered once USDC's reserve funds were redeposited into other banking institutions. CoinDesk (2023)

Crypto Pegged Stablecoins (DAI):

Through this type of stablecoin, everything is handled differently. Other cryptocurrency (like an Ethereum coin) is "locked" within a smart contract. Conversely, the equivalent of the value of the other cryptocurrency (DAI) is issued to you upon executing the smart contract. One important difference is that you have to put up 150% to 200% (collateral) in terms of the Dollar equivalent to the other crypto that you have locked, in order to offset any potential risk of decline in the price of the crypto you have locked. If the price of your collateral declines significantly, the smart contract will liquidate by selling your collateral to pay off your debt.

• No one has the ability to freeze your wallet -- you have a higher degree of freedom.
• The system is entirely transparent -- every smart contract and transaction is viewable.
• Is not tied-in with traditional banking systems -- instead the system works directly with the cryptocurrency.

The Cons:

• Risk of liquidation if your cryptocurrency declines significantly.
• Collateral management best suited for experts, as opposed to novices.
• The degree of decentralization is slightly lessened by adding custodial RWA (real-world asset) backing.

Real Event — March 12, 2020 "Black Thursday": Ethereum fell to $85. Some collateral smart contracts did not liquidate in time, resulting in a $4 million loss due to the MKR token covering the debt. The protocol remained functional, but it demonstrated numerous points of weakness in their system.

Algorithmic Stablecoins (UST)

To put it bluntly, these are arguably the most controversial of the three options. Algorithmic stablecoins do not have a fiat or crypto backing; rather they operate based on complex algorithms, as well as utilizing two separate tokens (1) the stablecoin and (2) the management tokens. Terra UST, paired with the LUNA token, was the classic definition of an algorithmic stablecoin. Arbitrageurs facilitate the burning and minting of tokens to stabilize the price around $1.

In May 2022, panic ensued when people rushed to withdraw UST due to Anchor Protocol's 20% APR. The Luna Foundation Guard pledged its reserves to the market, amounting to approximately $3 billion, primarily in Bitcoin. This was not enough to safeguard the UST payment system; it collapsed from $1 to $0.10, and LUNA fell virtually to zero. Consequently, $60 billion in market capitalization was lost, and the founder now faces prison time. Since this event, regulators have placed significant restrictions on the issuance and trading of algorithmic stablecoins.

"The UST depegging was primarily a result of panic selling/mass withdrawals and the failure of the algorithm to stabilize prices." - The Block (2022).

As a result, the trust in an algorithmic stablecoin is an important metric since the algorithmic stability of the stablecoin can only exist so long as there is trust in the underlying token.

A Detailed Overview of Stablecoins

USDT (Tether): History, Use Cases, and Criticisms

As the oldest and largest stablecoin, Tether (USDT) has a market capitalization of over a hundred billion dollars and is available on multiple protocols, including Ethereum, Tron, Binance Smart Chain, Solana, and Avalanche. Most transactions occur on the Tron protocol due to its low fees.

With regards to reserve assets, Tether claims that 85% of its reserves consist of cash and short-term US government debt, while the other 15% includes corporate debt and loans. However, Tether has never had a full audit by one of the "Big Four," and its financial statements are usually produced by the firm BDO.

Tether's use case includes global exchange and P2P transactions, for those in countries subject to transaction restrictions, and as a means for traders to lock in profits.

Tether has been criticized for its lack of transparency (insufficient auditing).

USDC (USD Coin): Issuers and Regulation

Circle (USA) and the Centre consortium issue USDC, which is fully transparent about its entire history; Grant Thornton conducts regular audits, and reserves are made of liquid cash stored at banks, as well as short-term government bonds. All aspects of USDC's issuance are strictly regulated.

USDC features include: relatively high transparency, integration into traditional financial services (as evidenced by a collaboration with Mastercard), and broad acceptance among institutional investors.

Risks associated with USDC include: reserves were held in seven different banks, and in March 2023, because of the bankruptcy of Silicon Valley Bank (SVB), the value of USDC fell to as low as $0.88 and then rapidly recovered; and the issuer has the ability to freeze or block any user's or potential user's account.

BUSD (Binance USD): Issuers and Regulation

BUSD is a partnership between Paxos and Binance and has been heavily regulated by NYDFS since the day of its launch/initial coin offering (ICO). Its reserves have been comprised of 100% cash (bank deposits) or T-Bills at the time of maturation. As of February 2023, NYDFS has ceased the issuance of any additional BUSD tokens.

Risks associated with BUSD include the open investigation of the issuer by the SEC, the fact that it is 100% dependent upon US regulation, and the fact that the market capitalization has dropped from approximately $16 billion to $3 billion.

UST (TerraUSD): Design and Collapse

UST was an algorithmically-backed stablecoin with two tokens, UST and LUNA. It collapsed due to mass withdrawals, insufficient reserves, and panicked selling by their holders. Its founders have now reportedly been arrested, and all of LUNA's market value has disappeared.

DAI (Maker DAO): Decentralization and Stability

DAI is an algorithmically-backed decentralized stablecoin supported by both cryptocurrency and real estate (real world asset = RWA). It was also first made available through a Decentralized Autonomous Organization (DAO). Although DAI survived a number of near-misses of complete destruction, it still has risk factors associated with potential delays in liquidation and partial centralization due to the use of RWA-based collateral.

Mechanisms to Maintain Stablecoin Value Support

Asset reserves and collateralization for all stablecoins are subject to the following conditions:

Reserves are composed of assets that are fully collateralized with assets that fully cover all issued tokens.

• Cash and bank deposits.
• US Treasury bonds.
• Commercial paper.
• Loans.

Custodian bank bankruptcy or loan default are significant risks for the reserves.

Algorithms stabilize these assets through rebasing or seigniorage as long as the demand for management tokens stays constant. Once trust is lost, stabilizers cease to function.

Oracles (e.g., Chainlink) send price data for liquidations and emissions, while smart contracts automate execution; however, both systems are prone to bugs.

Overall, the biggest risks with stablecoins are:

• Liquidity and trust. Liquidity refers to how fast you can exchange your token without incurring significant price slippage. If trust erodes, panic selling will occur, which will create an adverse effect on market liquidity. Diversification is important; use automation tools to help monitor these tokens (e.g., ASCN.AI).

"Traders rely increasingly on automated tools to monitor potential depegging scenarios. The ASCN.AI AI assistant monitors on-chain activity." – ASCN.AI

• Regulatory challenges and legislative hurdles. Countries are taking vastly different approaches to stablecoins. For example, in the US, SEC and CFTC have implemented new rules and have similar requirements for stablecoins; while in Europe, MiCA requires licenses and audits. While these laws provide some protection, they will also curtail the opportunities for stablecoins.
• A few high-profile failures involving stablecoins occurred recently:
  1. UST (May 2022): $60 billion loss in cap
  2. USDC (March 2023): USDC depegged to $0.88 due to significant selling pressure
  3. BUSD stopped issuing tokens (February 2023)
  4. Tether (2021): $41 million fine for misrepresentation.

Usage of Stablecoins

DeFi & Trading

All DeFi services rely on stablecoins. As examples, stablecoins are the underlying asset when you lend through Aave and Compound, provide liquidity on a decentralized exchange like Uniswap or Curve, farm for yield or arbitrage across markets. When Bitcoin dropped on October 11, 2024, the value of USDT on local exchanges was 1.05 — 1.05 — 1.07. ASCN.AI users who had set up automated alerts made immediate profits of 5–7%.

International Transfers and Payment Usage

Stablecoins improve international transfers by reducing both the time and cost needed to send money; this allows users to avoid being affected by currency sanctions and banking restrictions. Sending USDT allows for a transfer time of minutes whereas sending money via SWIFT could take days.

Future Trends and Innovations of Stablecoins

Central Bank Digital Currencies (CBDC) will provide competition for privately issued stablecoins; Real World Assets (RWA), such as real estate and bonds, will be held in reserves; cross-chain token bridges will enable tokens to be moved across blockchain platforms; AI algorithms will be used to automate risk warnings and conduct market and news analysis — ASCN.AI is one such service; and changes to regulations will promote more transparency within the stablecoin industry.

Frequently Asked Questions (FAQs)

What is the difference between stablecoins and non-stablecoins?
Stablecoins are pegged to stable (Fiat) assets and are worth approximately $1, versus Bitcoin which is extremely volatile.

Are all stablecoins safe?
Fiat backed stablecoins tend to be more stable, whereas algorithmically based stablecoins can be very risky.

Have stablecoins lost their peg?
Yes, they have. e.g. UST went to zero, USDC lost its peg at SVB, and USDT decreased to $0.95 before recovering quickly.

Which stablecoin is better; USDC or USDT?
USDT will provide higher liquidity, whereas USDC is more transparent and well governed.

Can I earn a profit using a stablecoin?
Yes, by using arbitrage (1–7%), lending in DeFi (5–15% return), staking, and/or farming.

How do I protect my stablecoins from depegging?
By diversifying between stablecoins (such as USDT, USDC, and DAI) and setting up alerts in ASCN.AI.

Is taxation applied to transactions involving stablecoins?
This varies by country; in many jurisdictions, exchanges trigger taxable events.

If my stablecoin loses its peg, what do I do?
First, evaluate if it's a temporary occurrence or a serious issue. Determine your risk level and exit your position if you are at high risk.