20.12.2024
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Stablecoins play an essential role in the DeFi ecosystem, enabling investors to use a price-stable asset for trading, lending, yield farming, and more. Bitcoin stablecoins are a specific type of stablecoin that have been designed to provide price stability in the Bitcoin DeFi ecosystem, allowing users to deploy a range of yield-earning strategies.
Read on to learn about Bitcoin stablecoins—how they work and why they are superior to stablecoins on other chains—and to discover some of the more popular Bitcoin stablecoins.
A stablecoin is a type of cryptocurrency that experiences low price volatility because its value is tethered to a stable asset like fiat money or gold. It serves as an alternative to volatile cryptocurrencies that experience wild price fluctuations.
Crypto users can employ stablecoins to provide price stability when exchanging value on the blockchain. Additionally, they can maintain the value of their crypto holdings during periods of high downward volatility by converting them to stablecoins.
Most stablecoins are fiat or commodity-backed, but they can also be pegged to a more established cryptocurrency like BTC or ETH or be solely based on an algorithm.
Ideally, the pegging ratio for stablecoins is 1:1, although in practice the price of a stablecoin can sometimes vary around the value of the currency it is tethered to.
Stablecoins are (relatively) price-stable digital currencies operating on blockchains. They differ in design depending on whether they are centralized or decentralized and on the type of collateral they use to achieve price stability.
Let’s look at how the different types of stablecoins work.
Fiat-backed stablecoins employ fiat currencies as collateral to maintain their peg. This collateral or reserve asset is usually held in off-chain custody with a regulated financial institution like a bank. That means fiat-backed stablecoins are centralized.
A stablecoin can be considered centralized whenever its collateral is held as fiat-denominated assets with the traditional banking system or its issuer has the power to freeze it, making it inaccessible. Commodity-backed stablecoins operate similarly, with the reserve asset usually being a precious metal held in a bank.
Since trust is of utmost importance when it comes to the success of a stablecoin, most issuers regularly publish audits of their reserves. This allows users to verify that the stablecoin has sufficient reserves to back it up. Reserve audits are generally performed by independent firms to ensure objectivity.
Fiat-backed stablecoins can be redeemed 1:1 for the off-chain reserve asset. Nevertheless, supply and demand dynamics can make the peg fall short of 1:1. If a stablecoin significantly deviates below its peg (e.g., drops to $.94), a depegging occurs. This event can result from inadequate collateral, diminishing trust in the issuer, regulatory changes, liquidity issues, or market volatility. An opposite event can also happen, causing a stablecoin to trade above its peg (e.g., $1.09). Such a scenario could result from temporarily increased demand for the stablecoin relative to the fiat backing it.
USD is the most commonly used form of stablecoin fiat collateral, but currencies like the Euro, British Pound, and Japanese Yen are also utilized.
Crypto-backed stablecoins rely on a crypto asset as collateral—usually a more established cryptocurrency—to maintain their peg and to be minted. They are issued on decentralized protocols built on Layer 1 or Layer 2 networks, and their collateral is usually stored on-chain. That means crypto-backed stablecoins are (more) decentralized.
Using a cryptocurrency to stabilize the price of another digital asset can only be achieved through over-collateralization. Over-collateralization allows the value of the volatile collateral asset to vary somewhat without dropping the collateral value below the peg value of the stablecoin. So, to mint $1 of a stablecoin, a user must lock up over $1 of collateral in a smart contract. The minted stablecoin is issued as overcollateralized debt, and the smart contract is responsible for adjusting the interest rate to retain the peg and to liquidate the collateral if the value drops too close to the value of the stablecoin.
MakerDAO’s DAI is an example of a popular crypto-backed stablecoin. The protocol accepts various Ethereum-based assets as collateral, even tokenized real-world assets. On the other hand, DLLR is an example of a crypto-backed stablecoin on Bitcoin.
Algorithmic stablecoins don’t require collateral. Instead, they use a smart contract to retain their peg by automatically burning coins when the price falls below the peg and minting new coins when the price exceeds the peg.
This process of automatically adjusting a stablecoin’s supply is called rebasing. It takes place on-chain, making algorithmic stablecoins decentralized.
Algorithmic stablecoins set a target peg by tracking a fiat currency or an index. For example, Ampleforth (AMPL) is an algorithmic stablecoin that tracks the 2019 Consumer Price Index (CPI)-adjusted US dollar. It is issued and minted on the Ethereum-based Ampleforth protocol.
UST (TerraUSD) was an algorithmic stablecoin that dramatically lost its peg in 2022. As a result of this experience, algorithmic stablecoins have largely fallen out of favor as a peg method.
Stablecoins on Bitcoin are low-volatile digital currencies minted on Bitcoin layers like Rootstock (RSK), Stacks, and the Liquid Network.
Creating stablecoins on Layer 2 is more efficient because the Bitcoin blockchain has limited smart contract functionality and scalability challenges, while Bitcoin layers are designed to be scalable and more programmable.
That said, Bitcoin-native stablecoins on Layer 1 are theoretically also possible thanks to Ordinals, a protocol that allows users to generate various types of tokens by inscribing (attaching) data to individual satoshis. However, Bitcoin’s slow transaction speeds and high fees will likely affect the ease of using these stablecoins to trade, lend, and conduct other on-chain activities.
Let’s take a look at several examples of stablecoins on Bitcoin.
Sovryn Dollar (DLLR) is a decentralized, overcollateralized Bitcoin-backed stablecoin running on Rootstock that tracks the price of USD on a 1:1 basis. It is minted using a smart contract known as Mynt.
DLLR maintains peg stability by aggregating a basket of Bitcoin-backed stablecoins such as ZUSD and DOC. ZUSD is a stablecoin minted by borrowing on Sovryn’s Zero protocol, while Dollar on Chain (DOC) is a stablecoin issued on Rootstock’s Money on Chain protocol.
DLLR is issued by the team behind the Sovryn dapp on Rootstock. Therefore, it is the default stablecoin for this application. You can mint DLLR directly on the Sovryn dapp by putting up BTC.
Liquid Tether (L-USDT) is the popular USDT stablecoin deployed on the Liquid Network. It is backed by USD and other dollar-denominated assets held by centralized institutions.
Users can acquire this stablecoin on crypto exchanges such as Bitfinex and SideShift AI. Alternatively, they can use BTC as collateral to acquire an L-USDT loan on the platform Hodl Hodl.
USDA is a decentralized stablecoin on Arkadiko, a liquidity protocol built on the Stacks Layer 2 network.
It is minted as overcollateralized debt by depositing Stacks tokens (STX) in a vault (smart contract) as collateral. Once minted, the stablecoin can be utilized to farm yields. USDA is pegged to USD at a ratio of 1:1.
Dollar on Chain (DOC) is a Bitcoin-backed stablecoin with a 1:1 USD peg. It is an asset on Money on Chain, the second most popular DeFi dapp on Rootstock after Sovryn.
The stablecoin’s Bitcoin collateral is held in a smart contract on Rootstock. Users can mint DoC by exchanging it for RBTC on the Money on Chain platform. RBTC is the wrapped version of Bitcoin on Rootstock.
rDAI is a bridged version of the DAI stablecoin on Rootstock. Since Rootstock is EVM-compatible, users can bridge assets to and from Ethereum.
To mint rDAI, a user must first lock DAI tokens on Ethereum. This action triggers a smart contract to mint an equivalent amount of rDAI on Rootstock. On the contrary, rDAI is burned when bridging back to Ethereum, and DAI tokens are unlocked. DAI is pegged to USD on a 1:1 ratio.
XUSD is an aggregated stablecoin on BabelFish, a cross-chain protocol built on Rootstock. It is pegged to the US dollar 1:1 and is backed by several stablecoins like USDT, USDC, and DAI.
These stablecoins can be redeemed 1:1 for XUSD. For instance, users can bridge USDT to XUSD from Ethereum to Rootstock. It’s also possible to bridge XUSD to USDT from Rootstock to Ethereum.
Bitcoin-based stablecoins are secured by Bitcoin, the safest blockchain network in the market because the Bitcoin layers they operate on tap into Bitcoin’s robust security while implementing different solutions to improve scalability and programmability.
Bitcoin’s high level of security is partly attributed to its limited smart contract functionality and block space cap. The former feature keeps the network safe from Denial of Service (DoS) attacks and programming errors, while the latter protects the network from spamming and DoS attacks.
Bitcoin has not been compromised or faced a significant outage in over a decade, making it the most suitable base infrastructure for the development of decentralized financial products and services.
BitcoinOS is a smart layer that supports the creation of digital assets, such as stablecoins, secured by Bitcoin.
The new off-chain protocol hosts multiple interoperable and composable Bitcoin rollups, allowing them to communicate directly with each other. Decentralized applications built on these rollups will be interoperable, enabling users to seamlessly hop from one dapp to another to allow users to utilize one dapp’s stablecoin on several other applications using near-trustless rails.
This shared economy is presently unavailable within the Bitcoin ecosystem, making BitcoinOS a leader in interoperable rollups. BitcoinOS is scheduled to launch on mainnet in Q4 2024.
Buy SOV to participate in Sovryn’s Bitocracy and have your say in the new era of Bitcoin.
Bitcoin isn’t a stablecoin. It is a cryptocurrency that doesn’t rely on another asset for price stability. For this reason, Bitcoin sometimes experiences periods of high volatility, although these fluctuations have dwindled compared to its earlier days. According to DataTrek, Bitcoin is becoming more price stable due to institutional interest.
Stablecoins are cryptocurrencies whose value is pegged to price-stable asset classes like fiat money and commodities. This makes their prices more predictable, allowing users to trade, lend, or borrow with them. On the contrary, Bitcoin is a decentralized digital currency that doesn’t rely on another asset for its value or price stability. Currently, this is associated with more volatile price fluctuations.
Stablecoins have lower price volatility than Bitcoin, making them more predictable for trading, lending, and performing other DeFi activities. As long as the peg holds, users don’t have to worry that the value of the asset they’re holding will decline significantly over time relative to the asset it tracks. That said, Bitcoin is the better asset in all other aspects because it is decentralized, secure, a store of value, trustless, and liquid.
Yes. Algorithmic stablecoins have been known to depeg and completely fail to recover. The fact that these stablecoins rely on an algorithm for peg stability and don’t have collateral makes them riskier than fiat or commodity-backed stablecoins. Still, stablecoins tethered to fiat can depeg when the reserve asset is inadequate, the institution holding the collateral loses trust, or market liquidity changes.
Fiat and commodity-backed stablecoins expose holders to counterparty risk because they depend on banks to safeguard the reserve assets. If something goes wrong (e.g., a bank filing for bankruptcy), the reserve asset is compromised, leaving the stablecoin unbacked. This can result in a depeg, causing investors to lose money. On the other hand, algorithmic and crypto-backed stablecoins can lead to losses when the smart contract that maintains peg stability fails or market forces force the stablecoin to depeg.
