How Crypto Works. Stablecoins

The question arises: why issue some new tokens worth $1 instead of using the dollar itself? The fact is that the dollar is not compatible with decentralized applications running on blockchains. A transfer in dollars cannot be recorded in a blockchain transaction since the dollar does not exist in the blockchain system. This means it is impossible to formulate any obligations in dollars through smart contracts. In addition, cryptocurrency transactions are not yet as tightly controlled by governments as fiat currency transactions, and sometimes, you cannot pay in dollars, but you can pay in USDT.

Let’s first imagine that a state has decided to issue a national currency, the exchange rate of which always equals one dollar. For example, let’s call this currency the Mongolian tugrik. How can this be technically implemented? For people to consider the tugrik as the equivalent of a dollar and base their payment transactions on the value of a tugrik at 1 dollar, they must know that at any time, tugriks can be exchanged for dollars at a rate of 1:1. To do this, the state will have to create an agency to which a certain amount of tugriks can be brought at any time and the same amount of dollars can be received for them without complicated bureaucratic red tape. The maintenance of the value of the tugrik will work as follows. If the rate falls to 99 cents, stock traders will buy the cheaper tugrik for 99 cents and sell it to the state for 1 dollar, receiving 1% profit. Since this operation will be carried out automatically by the trading software, it will happen instantly, the excess of tugriks on the market will be quickly liquidated, and the rate will return to $1. If the rate rises to 1 dollar and 1 cent, the opposite process will occur: the state will buy additional dollar reserves, sell the tugriks it has (or tugriks issued by emission), and receive 1% of the profit.

Ideally, the state should have a dollar reserve equal to the number of tugriks issued. At first glance, this seems pointless — the state withdraws from circulation (reserves) a certain amount of dollars, renames them tugriks, and issues them under the guise of its currency instead of not taking unnecessary steps and simply accepting the dollar as the national currency. The point is that such a state can always untie the national currency from the dollar if it deems it profitable.

Tether did something similar by issuing the USDT token, which trades at $1. To get USDT, a user can deposit dollars into a Tether bank account, after which Tether will issue an equivalent amount of USDT and give it to the user. If the user wants to eliminate them, he will return these tokens to the company, and Tether will return his dollar deposit. The company makes a profit by storing the dollars received from users in various assets that generate income. According to the company, the value of the issued tokens is 100% backed by reserves of tangible assets. At the same time, nothing is known about cases of independent audits of Tether reserves. There are accusations that they do not have sufficient dollar collateral. I wouldn’t go so far as to say that the company is simply printing money. Still, its reluctance to disclose complete financial statements may indicate that its reserves are stored in high-yielding but unreliable assets that traditional banks are not allowed to store. After a dispute with the US Commodity Futures Trading Commission (CFTC), the company paid $41 million in fines for violating specific regulations — in particular, due to the incomplete fiat backing of USDT tokens and the lack of an actual independent audit of the company’s reserves.

Tether exacerbates doubts about USDT’s reliability and is not legally obligated to redeem USDT and exchange it for dollars. Currently, Tether performs such redemptions by maintaining a stable exchange rate for USDT, but it does so voluntarily.

USDT is a fungible token. You may have heard of non-fungible tokens (NFTs). In contrast, fungible tokens are equivalent to each other, just as one unit of ether is equivalent to any other. The fungibility of these tokens makes them a suitable solution for implementing digital currencies like USDT. On the Ethereum network, USDT is supported by a smart contract written and hosted by Tether. The contract stores the balance of USDT for each user in its memory and allows users to exchange USDT tokens by calling methods on the contract. If one user sends a transaction to the contract with a call to the Transfer method to transfer 5 USDT to another user’s account, then in the internal memory of the contract, the balance of the first user decreases by 5, and the balance of the second user increases by 5.

The code of this contract uses such an entity as a blacklist, which allows Tether to freeze all USDT for any user without explanation. This allows us to claim that USDT is even more centralized than the dollar, which contradicts the idea of ​​cryptocurrencies. USDT can be used as a means of payment for some short-term purposes, but it would be very unwise to store your savings in it. In addition to Ethereum, USDT smart contracts work on the Omni network (a smart contract system built on the Bitcoin network), Tron, Solana, EOS, and Algorand.

The second most popular stablecoin, USDC, is considered more reliable than USDT since the company that issued it, Circle, is considered more transparent. In addition, if you want to exchange your USDT for dollars with Tether, such redemption must be at least $ 100,000. For USDC, the minimum amount is only $ 100.

DAI, the third stablecoin by market capitalization, is built on different technical principles and deserves special mention. Unlike USDT and USDC, it is managed decentrally, is not controlled by any one legal entity, and is backed by many small cryptocurrency reserves distributed across different accounts. The MakerDAO protocol operates on the Ethereum network and determines the value of Ether in dollars using oracles — special smart contracts in which financial market players publish the current Ether rate obtained from information sources outside the Ethereum network. To neutralize unscrupulous oracles, methods for filtering out abnormal values ​​are used (for example, the median of values ​​provided by many oracles can be taken). Due to the participation of oracles, the system cannot be called fully decentralized.