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The Future of Stablecoins: Centralized or Decentralized?

Key Takeaways:
  • Stablecoins maintain value by linking to fiat currencies, like USD, making them less volatile than other cryptos.

  • Centralized stablecoins come from a central authority, while decentralized ones are issued by a network of nodes.

  • PAX's centralized features and use of an older Solidity compiler raise concerns about its actual decentralization and security.

  • Decentralized stablecoins split into algorithmic (using algorithms to adjust supply) and overcollateralized (backed by extra collateral).

  • FRAX manages its supply based on demand, creating or destroying tokens to keep its value near $1.

  • DAI requires users to overcollateralize with more assets than they mint, ensuring stability even if collateral value drops.

  • Liquity lets users borrow LUSD with ETH collateral, keeping LUSD's value at $1 through a stability pool, unlike some other protocols, it isn't controlled by a DAO.

  • Decentralized stablecoins are more secure, transparent, and scalable due to their decentralized nature and open algorithms.

  • Decentralized stablecoins like LUSD are set to grow in importance, offering security, transparency, and scalability, becoming essential for the expanding crypto landscape.

Stablecoins are cryptocurrencies that are designed to maintain a stable value, typically by being pegged to a fiat currency like the US dollar. This makes them more stable than other cryptocurrencies, which can be very volatile.

What Are Centralized Stablecoins?

Centralized stablecoins are issued by a central authority, such as a company or a bank. This makes them more centralized and less transparent than decentralized stablecoins. Centralized stablecoins have also been the subject of depegging events in recent months.

In June 2023, USDT briefly depegged from the US dollar. This was due to an imbalance in Curve Finance's 3pool, a decentralized stablecoin pool that holds significant liquidity in three major stablecoins: USDT, USD Coin (USDC), and Dai (DAI). The imbalance in the 3pool caused a sell-off of USDT, which drove the price down to as low as $0.996. However, the price quickly recovered and returned to its peg within a few hours.

PayPal made its own stablecoin, which doesn't change in value as much as other digital currencies like Bitcoin. This is great for companies that want to use digital money but are worried about big price changes. Because of PayPal's move, other fintech companies might start using stablecoins too. These stablecoins can help with fast payments, especially to other countries, and can be used with other digital currencies easily. They also follow rules set by governments. In the future, we might see more companies using stablecoins for things like loans or insurance. All in all, stablecoins have a big future ahead!

What You Need to Know about PayPal Stablecoin:

PayPal launched its own stablecoin called ( PYUSD) in August 2023 It is a dollar-pegged stablecoin that is issued by Paxos Trust Company. Paxos is a regulated financial institution that is also the issuer of the Paxos Standard (PAX) stablecoin.

The contract code for PAX gives PayPal a number of control features, including the ability to freeze and unfreeze accounts, wipe and burn tokens, and centrally manage the supply. This has led some to question whether PAX is truly decentralized. In addition, PAX uses an older version of the Solidity compiler, which could make it more vulnerable to security vulnerabilities.

Overall, PAX's centralized nature could also make it a good bridge between traditional finance and DeFi. Because it is regulated and backed by a large company like PayPal, it could give institutional investors and other traditional finance players more confidence in using stablecoins. This could help to increase the adoption of stablecoins and DeFi more broadly.

What Are Decentralized Stablecoins?

In recent years, there has been a lot of interest in decentralized stablecoins. These stablecoins are not issued by a central authority, but rather by a decentralized network of computers. This makes them more secure and transparent than centralized stablecoins.

There are two main types of decentralized stablecoins: algorithmic stablecoins and overcollateralized stablecoins.

Algorithmic Stablecoins

These stablecoins use algorithms to maintain their peg to the US dollar. They do this by adjusting the supply of the stablecoin in circulation based on demand. If the price of the stablecoin goes above $1, the algorithm will mint more of the stablecoin, which will drive the price down. If the price of the stablecoin goes below $1, the algorithm will burn tokens, which will drive the price up

FRAX is an algorithmic and decentralized stablecoin. It is backed by a mixture of collateralized debt positions (CDPs) and FRAX Shares (FXS). CDPs are created when users deposit collateral into the FRAX system, and they can then mint FRAX tokens. FXS are tokens that represent ownership of the FRAX system, and they can be used to redeem FRAX tokens at a 1:1 ratio.

The FRAX system uses an algorithm to adjust the supply of FRAX tokens in circulation to maintain its peg to the US dollar. If the price of FRAX goes above $1, the algorithm will mint more FRAX tokens, which will drive the price down. If the price of FRAX goes below $1, the algorithm will burn FRAX tokens, which will drive the price up.

Overcollateralized Stablecoins

Overcollateralized stablecoins are a type of decentralized stablecoin that are backed by more collateral than they need to be in order to maintain their peg. This means that if the value of the underlying collateral falls, the stablecoin will still be able to maintain its peg.

One example of an overcollateralized stablecoin is DAI, which is issued by the MakerDAO platform. DAI is pegged to the US dollar, and in order to mint DAI, users must deposit 150% of the value of the DAI they want to mint in collateral. This means that for every $100 of DAI that is minted, $150 of collateral must be deposited.

The excess collateral helps to protect DAI from volatility in the underlying collateral. If the value of the collateral falls, the MakerDAO platform will be able to sell some of the collateral to maintain the peg of DAI.

The MakerDAO platform is also governed by a DAO, which means that it is decentralized and controlled by the community. This helps to ensure that DAI is a secure and transparent stablecoin.

Another example of a decentralized stablecoin is Liquity. Liquity is an overcollateralized stablecoin that is pegged to the US dollar. It is unique in that it does not require any third-party intermediaries, such as exchanges or custodians. Instead, it uses a decentralized system of smart contracts to manage the minting and burning of LUSD tokens.

Liquity Borrowing Protocol

Liquity is a decentralized borrowing protocol that allows users to borrow a stablecoin called LUSD against their ETH collateral. The protocol is unique because it uses a stability pool mechanism to ensure that the value of LUSD remains at $1. If the value of the collateral falls below the 110% collateralization ratio, the stability pool will automatically liquidate some of the borrower's collateral to pay off the LUSD debt. This helps to ensure that LUSD remains overcollateralized and that the protocol remains solvent.

Liquity is not governed by a DAO. The protocol is completely immutable, and there is no governance mechanism in place. This means that there is no central authority that can make changes to the protocol, and all decisions are made by the community through a consensus mechanism.

This design decision was made to ensure that Liquity is as censorship-resistant as possible. If there were a DAO that governed the protocol, it could be subject to attack or manipulation by bad actors. By making the protocol immutable, Liquity is able to protect itself from these threats.

Key features of Liquity:
  • Interest-free loans: You can borrow LUSD against your ETH collateral without paying any interest.

  • High collateralization ratio: The protocol requires a 110% collateralization ratio, which means that you need to deposit $1.10 worth of ETH for every $1 worth of LUSD you borrow.

  • Stability pool mechanism: The stability pool helps to ensure that the value of LUSD remains at $1. If the value of the collateral falls below the 110% collateralization ratio, the stability pool will automatically liquidate some of the borrower's collateral to pay off the LUSD debt.

  • ETH-only collateral: The protocol only accepts ETH as collateral.

Final Thoughts on Centralized and Decentralized Stablecoin

The future of centralized stablecoins is uncertain. The recent collapse of TerraUSD and depegged USDC has raised questions about the security and stability of centralized stablecoins. Centralized stablecoins are typically backed by fiat currency reserves, which means that they are vulnerable to bank runs if there is a run on the bank. Additionally, centralized stablecoins are subject to government regulation, which could make them less attractive to users.

However, Big fintech companies like PayPal could play a role in filling the trust gap that has been created by the collapse of TerraUSD or USDC's depegging. These companies have a good track record and are trusted by users. Additionally, they have the resources to invest in secure and transparent stablecoin systems. so paypal stablecoin could help to restore confidence in centralized stablecoins and make them more attractive to users.

Decentralized stablecoins are expected to play a bigger role in the cryptocurrency ecosystem in the future. They offer a number of advantages over centralized stablecoins, such as being more secure, transparent, and scalable. As the cryptocurrency market grows, decentralized stablecoins will become an essential part of the infrastructure.

Here are some specific advantages of decentralized stablecoins:

  • Security: Decentralized stablecoins are not controlled by a single entity, so they are less vulnerable to fraud or manipulation.

  • Transparency: The algorithms that control decentralized stablecoins are open source, so anyone can see how they work.

  • Scalability: Decentralized stablecoins are not limited by the capacity of a single entity, so they can handle a lot of transactions.

These advantages make decentralized stablecoins are a good choice for people who want to store value or make payments in a secure, transparent, and scalable way. They are also expected to become more widely used as the cryptocurrency market grows. However, there are some risks associated with decentralized stablecoins like regulations and smart contracts risks, so investors should carefully consider these factors before investing

For fintech companies, this stable foundation becomes a gateway to integrate crypto solutions into their platforms with less financial risk. From quick, borderless transactions to ensuring compliance with evolving regulations, stablecoins offer a robust framework for seamless financial operations. Their interoperability facilitates seamless transactions between different fin-tech apps and well as with the traditional banking system.

Beyond mere transactions, the potential of stablecoins also extends into the burgeoning world of Decentralized Finance (DeFi), which promises to democratize financial services, providing access to those previously underserved by traditional banking. As fintech companies venture deeper into this digital frontier, stablecoins like PAX may well become the backbone of a new, more inclusive financial era.

The regulatory environment for stablecoins is still evolving in the Middle East. This can make it difficult for businesses to know which stablecoins are compliant with local laws. The infrastructure for stablecoins is still developing in the Middle East. This can make it difficult for businesses to find reliable and affordable ways to acquire and use stablecoins.

If you are a business in the Middle East that is interested in adopting stablecoins, please contact Pend Hub today. We can help you get started with stablecoins and start enjoying the benefits they have to offer.

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