Centralized vs. Decentralized Stablecoins: Importance and Impact in Crypto Space

Salomon Kisters

Apr 29, 2022

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Stablecoins are essential in the crypto space. They have the main advantage of protecting traders and investors against the massive market swings.

Everyone knows that the crypto space is all about volatility, and stablecoins can fight this issue.

This is also one of the reasons for which experts say that stablecoins are contributing to raising trust in the crypto space, therefore boosting the mass adoption of digital assets and their underlying tech, the blockchain.

Stablecoins have a pegged value, such as the US dollar or any other currency. This reduces volatility, and stablecoins, just like all digital money, can easily be transferred.

In terms of centralization, there are two types of stablecoins out there: centralized and decentralized. This article will address the main differences and everything that you need to know about them.

Centralized vs. decentralized stablecoins

Stablecoins aim to be secure and stable digital money to hold. This way, they promote mass crypto adoption.

Stablecoins can act just like a midpoint between holding assets and withdrawing to the fiat currency. Such coins are effectively used for executing cross-border payments.

Stablecoin prices are pegged to a reserved asset most of the time, such as the US dollar. They help reduce volatility compared to coins such as Bitcoin.

Centralized stablecoins

Centralized stablecoins are usually fiat collateralized off-chain. These are connected with a third-party custodian such as a bank.

In the crypto space, a centralized crypto exchange implies the fact that most of the control over your account will remain in the hands of a third party.

This is the entity that runs the exchange. On the other hand, regarding a decentralized exchange, things are quite different. All the control over your assets remains with you.

This is an important reason why decentralized exchanges are growing in popularity these days when financial freedom could not be more important.

When we’re talking about centralized stablecoins, stability is achieved via the 1:1 backing of tokens with the corresponding asset.

Some of the most important examples of centralized stablecoins are Tether (USDC) and Coinbase (USDC). There are more additions to the list of important centralized stablecoins such as TUSD, PAX, BUSD, and GUSD.

These are tokenized IOUs that are deployed onto a blockchain such as Ethereum. Another important issue is the fact that centralized stablecoins can balance the supply and demand via minting and redemption mechanisms.

In this case, users can mint stablecoins by depositing the equivalent amount of fiat to the custodian, redeeming, or burning the tokenized versions to retrieve fiat money back.

Top three centralized stablecoins

Tether (USDT)

Tether is one of the most popular stablecoins out there. It was launched back in 2014 as RealCoin. Its purpose was to always be worth the US dollar. This supply of the coin is limited by claimed dollar reserves. It is also the largest stablecoin. This is the reason for which there is always a massive amount of pressure on Tether to compile regular reports about its reserve. Tether has to prove that its value will remain the same as one USD.

TrueUSD (TUSD)

TUSD is another popular stablecoin that is centralized, and it had a limited launch back in 2018. TUSD claims to conduct regular audits, and it’s the first one that is fully backed by the US dollar. The audit of the stablecoin shows that the supply is limited by the dollars that they hold. More than that, TUSD allows for DeFi and staking to earn returns from holding.

USD Coin (USDC)

USDC is a digital currency that is fully backed by the US dollar. USDC is a tokenized US dollar, and the value of one USDC coin is pegged 1:1 to the value of the US dollar. As Investopedia notes, the value of USDC is designed to remain stable, and this makes USDC a stablecoin.

It’s also worth noting that USDC is managed by Centre. This is a consortium that is co-founded by two important entities: the important crypto exchange Coinbase and Circle, a financial technology company.

According to Investopedia, Centre’s target, among others, is to change the global financial landscape. How does it plan to do this? By connecting every person, merchant, financial service, and currency all over the world.

Decentralized Stablecoins

Decentralized stablecoins are fully transparent, and they are non-custodial. This means that no one can control decentralized stablecoins. Also, more than that, all collateral backing is visible to all as funds are on a publicly verified blockchain.

It’s important to understand that this allows stablecoins to be trustless and secure. Decentralized stablecoins can be divided into two parts – crypto collateralized and algorithmic.

The algorithmic stablecoins use smart contracts or algorithmic market operations controllers in order to automatically control their supply.

Top 3 decentralized stablecoins

DAI token

MakersDAO’s white paper notes that DAI is generated, backed, and kept stable via Ethereum-based currency deposited into MakerDAO’s vaults.

The deposited funds work as collateral when users want to withdraw their DAI currency. MakerDAO can keep its stablecoin pegged to the US dollar at a 1-to-1 ratio.

EOSDT

This is a popular crypto that operates on the EOS platform. It has a currency supply of 2,642,505.29330823.

This refers to itself as a dollar-pegged currency that leverages underlying EOS and BTC collateral that adds more liquidity to the market.

The coin is very stable as the stability mechanisms are embedded in smart contracts to maintain a 1:1 parity with the US dollar.

DeFi dollar (DUSD)

This is built as a stablecoin, and it uses the primitives of DeFi in order to remain close to the dollar. The coin offers investors an opportunity to index varying stablecoins in its single token. More than that, it protects users from underlying risks.

It’s collateralized by the Curve Finance liquidity provider (LP) tokens, and it is also using Chainlink oracles with the main aim of stabilizing itself. More than that, to offer people maximum safety, it also provides a staking mechanism, adding more protection.

The path to stablecoin decentralization

Centralized or fiat-backed stablecoins are run and controlled entirely by private companies that issue them and receive traditional bank deposits in return. This is as a reward for issuing their currencies to customers. These are the most popular stablecoin designs on the market.

But it’s important to acknowledge that there are various legal issues that come with exchanging traditional digital money with centralized stablecoin issuers. This is the reason which led various entrepreneurs to take on the challenge of hopping into the decentralization wagon. They started to create decentralized solutions that offer the on-chain financial stability that most crypto traders require.

There are indeed various social benefits of having centralized stablecoins issuers such as Circle – these help prevent money laundering and financing terrorist activities. They are doing this by blacklisting addresses that they believe are engaging in suspicious financial activities. Such dictatorships are not something to strive for.

On the other hand, decentralized stablecoins do not face such legal restrictions, and they can achieve global adoption outside of crypto exchanges and the limitations of the economies.

“The Quest for a Truly Decentralized Stablecoin”

Last year, CoinDesk wrote a piece called “The Quest for a Truly Decentralized Stablecoin.”

They begin their article by saying that “algorithmic stablecoins, which maintain their pegs without collateral, are either a fool’s errand or simply a matter of time.”

The prestigious publication brings up the days of the American economy, which flaunted the gold standard. It also noted that, in time, the country needed more flexibility than this.

“It doesn’t work in the long run because the economy is still expanding faster than the amount of materials available,” Lisa Jy Tan, founder of Economics Design, a crypto-economics research company, said as quoted by CoinDesk.

She is also quoted saying that the crypto economy will outgrow a collateral obligation. An algorithmic stablecoin will be able to keep its peg using software and rules – if such a thing works, it could reportedly scale infinitely to any kind of size that an economy needs.

Tan just concluded a study on stablecoins that are either fully algorithmic or could evolve in that direction over time. She concluded the study by saying that none are ready at the moment.

Without stablecoins, there would have been no DeFi booms, and this means that we would have no NFT booms either. Experts note that stablecoins have been the table stakes for what the crypto industry has managed to achieve so far.

Kory Hoang, CEO of Stably, which is an asset tokenization startup (it once issued its own stablecoin), also addressed the next phase – “meta-stablecoins.”

According to Hoang, these are stablecoins that exist in smart contracts, using them and giving depositors tokens that account for their deposits.

Such meta-stablecoins have unique properties, and they are either growing in value or surging in quantity based on the success of the deposit.

Final Words

Stablecoins are here to stay, and there’s no doubt about that. People are not hopping into the stablecoin wagon to catch fast gains – this is about stability, and this is what the stablecoins are driven by.

The way in which people view money these days is as a medium of trust that they have. Just as Huang said: “Trust is something that is very hard for us to measure or predict. If over time more and more people come to trust the system and more and more people come to use it, it could potentially work out.”

People trust things that are useful. So, make sure to keep an eye on projects that seem to put use cases before buzz and before simply issuing a bunch of tokens to stakers. A good project is not about having the most clever design; it’s about standing up and building a strong and motivated ecosystem.

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