Stablecoins: The "Universal Currency" of the Web3 World

The “Roller Coaster” Dilemma in Paradise

You are now a hot dog vendor at an amusement park. You’ve discovered a huge problem: the park’s official “game tokens” (like ETH) are as volatile as a roller coaster!

Monday: One game token equals 1 USD, and you price your hot dog at 3 tokens.

Tuesday: The game token surges, now worth 2 USD each! The hot dogs you sell, when converted to USD, have doubled in price, causing customer complaints.

Wednesday: The game token crashes again, now only worth 0.5 USD. Your hot dog price is halved, leaving you with losses and tears.

Under these circumstances, business is impossible! Not only for you, but all merchants and even visitors in the park desperately need a stable “currency” for daily transactions and savings.

To solve this problem, the park’s management (actually, the community developers) introduced a brilliant solution: Stablecoins.

What are stablecoins? The “USD vouchers” in the park

Stablecoins, as the name suggests, are cryptocurrencies with stable value.

How do they stay stable? The method is simple: peg them 1:1 to the most stable asset in the real world — usually the US dollar.

In other words, the park issues a special “voucher” (stablecoin) and makes a solemn promise:

“Anytime, you can exchange 1 USD at our redemption point for 1 voucher. Likewise, you can exchange 1 voucher back for 1 USD at any time.”

This way, the “voucher”’s value is essentially equal to 1 USD. Your hot dog can confidently be priced at 3 vouchers, no longer worrying about raw material cost fluctuations.

Stablecoins are the “USD” in the Web3 world. They are the most important bridge between the turbulent crypto ocean and the calm, real-world financial continent. They allow you to have a safe “harbor” when you want to avoid market volatility, and serve as the most mainstream unit for pricing and settlement in various transactions and financial activities. The most famous stablecoins include USDT (Tether) and USDC (USD Coin).

Sources of trust: How do stablecoins maintain “stability”?

You might ask: “This promise sounds great, but why trust it? What if I exchange vouchers for USD and the redemption point says they have no money?”

Good question! To make this promise credible, three different “collateralization” methods were invented.

First: The simplest and most direct “bank vault” model (Fiat-collateralized)

How does it work? The issuer (e.g., Circle, which issues USDC) deposits 1 USD in a real bank account for every USDC token issued on the blockchain. Issuing 100 million USDC means 100 million USD stored in the bank. These funds are regulated and audited to ensure transparency.

Advantages: The logic is straightforward, easy to understand, and most trusted by the market.

Disadvantages: It is centralized. You must fully trust the issuing company. If their bank fails or they are frozen by authorities, there is a risk.

Second: A more “native blockchain” approach — the “collateralized debt position” (Crypto-asset-backed)

How does it work? Some decentralized advocates believe, since this is Web3, why trust a centralized company? So they created an “automated collateralized loan” system (like MakerDAO issuing DAI). To get 100 DAI (a stablecoin worth 1 USD), you don’t need fiat currency. Instead, you over-collateralize with more valuable crypto assets (e.g., ETH worth $150). You lock this collateral into a smart contract, and the system automatically “loans” you 100 DAI. Because of the over-collateralization, DAI’s value is maintained.

Advantages: Decentralized. You trust transparent, automated code rather than a company.

Disadvantages: More complex mode, lower capital efficiency (due to over-collateralization), and potential smart contract hacking risks.

Third: The “magic of algorithms” — an unbacked “algorithm stablecoin” — a cautionary tale

How does it work? This boldest design has no real assets backing it. It tries to maintain the price of one token at 1 USD through a complex set of algorithms that control the supply and demand of two tokens, aiming to keep one stable.

It’s like a tightrope performer without a safety net, relying solely on a balancing pole (the algorithm). Looks graceful most of the time, but if market conditions turn extreme, the balance can break, leading to a sudden fall.

A painful lesson: A famous algorithm stablecoin called UST used this model. In May 2022, it faced extreme market attack, the algorithm failed, triggering a “death spiral,” and its price plummeted from 1 USD to near zero within days. Its supporting token LUNA also vanished, causing hundreds of billions of dollars in losses.

What have we learned? This event taught all Web3 newcomers a profound lesson: “Stability” without sufficient, high-quality backing assets is extremely fragile and a house of cards.

Conclusion: Your “safe harbor” in Web3

Now, you have a comprehensive understanding of stablecoins. They are your most important and commonly used “currency” and “safe harbor” in the turbulent crypto world.

When you feel uneasy about market fluctuations, you can convert your ETH or BTC into USDT/USDC, locking in profits and avoiding risks.

When participating in most DeFi or NFT transactions, stablecoins are also used for pricing and settlement. **$USDC $USD1 **