Bitcoin Stablecoins: A Complete Beginner's Guide
Learn about Bitcoin stablecoins and their role in the fast-growing DeFi ecosystem being built on Bitcoin.
There’s a growing demand for Bitcoin-based stablecoins, which provide a degree of price stability for the burgeoning Bitcoin DeFi ecosystem. Built on top of Bitcoin, Bitcoin stablecoins power a range of use cases, from borrowing and lending to yield farming and more.
Read on to learn more about Bitcoin-powered stablecoins and how they are used in the Bitcoin DeFi market.
What Are Stablecoins?
Stablecoins are digital currencies designed to maintain a stable price by aiming to link their value to price-stable assets like fiat currencies or commodities like gold.
Digital currencies that aim to track the value of the US dollar, like sUSD and #USD, combine the trust and stability of the US dollar with the accessibility and programmability of cryptocurrencies, providing the best of both worlds to the crypto asset markets.
Stablecoins have emerged as one of the most popular types of crypto assets among investors in the DeFi markets as they enable holders to deploy yield-generating strategies in the DeFi markets while alleviating most of the market risk of traditionally volatile cryptocurrencies, such as Bitcoin (BTC).
What Are Bitcoin Stablecoins?
Bitcoin stablecoins are cryptocurrencies that operate within the Bitcoin ecosystem that aim to provide a high degree of price stability.
Bitcoin stablecoins are either minted directly on the Bitcoin blockchain or on layer-2 networks like Stacks, Rootstock, or the Liquid Network. Layer-2 networks are built on top of Bitcoin and are connected to the Bitcoin base layer in various ways. Each layer supports an ecosystem of dApps where stablecoins are used.
Besides layer-2 networks, stablecoins can now also exist on the Bitcoin base layer thanks to Ordinal Theory. Ordinal Theory is a methodology introduced by software engineer Casey Rodarmor to allow for the identification and tracing of individual satoshis (sats) within the current Bitcoin circulation, enabling the attachment of digital assets or content, such as images, text, videos, or stablecoins, to a satoshi. Sats represent the smallest (one-hundredth millionth) unit of Bitcoin. To enable this, no changes to the Bitcoin protocol were necessary, thanks to Ordinal Theory.
As a matter of fact, Ordinal Theory is not implemented on the protocol level. Therefore, users rely on the Ord software to generate stablecoins and other assets utilizing Ordinal Theory.
How Do Bitcoin Stablecoins Work?
To allow for a high degree of price stability, most stablecoins use some type of collateral that is either off-chain (fiat instruments) or on-chain (crypto asset). Such collateral is needed to credibly defend the price peg.
Given there is a stablecoin issuer, a reserve for storing the asset or basket of assets backing up the stablecoin is set up. This way, all the stablecoins in circulation are backed by an equal amount of the assets in reserve. For example, 1 billion units of a stablecoin may be backed by 1 billion USD or USD-denominated assets.
Stablecoins whose reserve assets are held with traditional intermediaries like banks are centralized. They are subject to centralization risks, like the collapse of the custodian holding the funds backing the stablecoin.
Alternatively, stablecoins can use smart contracts to store their reserve assets on-chain, making them decentralized because they rely on crypto assets as collateral. While these type of stablecoins don’t suffer from centralization risk, they face other risks, such as potential smart contract vulnerabilities or a breakdown of the stabilization mechanism.
Reserve assets that act as collateral are removed from the reserve every time a user cashes out and thus redeems a blockchain-based US dollar token for a traditional US dollar instrument.
Security Provided by Bitcoin
Every Bitcoin stablecoin issuer employs a distinct method to achieve price stability and manage the supply. However, all Bitcoin stablecoins are secured by the Bitcoin blockchain in some form, providing users with assurance that their transactions are processed by the most secure blockchain network in the world.
Bitcoin layer-2 networks are connected to the main chain in different ways, allowing them to benefit from Bitcoin’s superior security. Moreover, these layers may offer faster and cheaper stablecoin transactions as they aim to scale Bitcoin usage.
Examples of Bitcoin Stablecoins
Stably USD is issued by Stably, a stablecoin-as-a-service provider offers fiat on/off ramps for blockchains, allowing users to easily buy and sell stablecoins and other digital assets. The company introduced #USD in May 2023.
However, Stably held the reserves backing #USD with Prime Trust, a cryptocurrency infrastructure provider that has recently been put into receivership, forcing Stably to halt several of its stablecoin services, including minting and redemption. Stably is currently looking to find a new custodian to work with so that the company can continue offerings its stablecoins.
You can securely store BRC-20 tokens using the Xverse BRC-20 wallet.
sUSDT is a wrapped version of the USDT generated when you bridge USDT from Ethereum to Stacks. Tether USD (USDT) is a stablecoin backed by reserve assets consisting of USD and a basket of other financial instruments like corporate bonds, precious metals, and Bitcoin. USDT was launched in 2014 by Tether Limited Inc.
A wrapped token represents a digital asset from another blockchain. Therefore, sUSDT represents Ethereum-based USDT in this case. When bridging USDT from Ethereum to Stacks, USDT is locked on the Ethereum blockchain, and an equal amount of sUSDT is minted on Stacks. The conversion is 1:1, meaning when 10 USDT is locked on Ethereum, 10 sUSDT is minted on Stacks simultaneously.
ALEX Bridge connects Stacks and Ethereum, permitting the movement of assets between the two networks. The ALEX bridge mainnet went live in April 2023. sUSDT was rolled out to streamline the implementation of the ALEX bridge. The total supply of sUSDT as of this writing is 118.59 million.
To recap, Stacks is a Bitcoin layer-2 network that benefits from Bitcoin’s security. Developers can create smart contracts, dApps, NFTs, and stablecoins on Stacks. Moreover, you can store Stacks-based stablecoins and other assets in your Xverse wallet.
USDA is a stablecoin backed by Stacks (STX) with a soft peg to the US dollar. It’s issued on Arkadiko, a DeFi protocol built on top of the Stacks chain. Protocol users can mint and borrow USDA by depositing STX tokens as collateral in a vault.
USDA borrowers must overcollateralize their loans, meaning they have to deposit STX (Stacks native digital asset) higher in value than the loans they receive. As of this writing, the total value locked (TVL) on Arkadiko is $1.27 million. USDA was launched in 2021, and you can securely store and manage it using your Xverse wallet.
L-USDT, Liquid USDT, is Tether on the Liquid Network. The stablecoin is backed by USD and other dollar-denominated assets. USDT was deployed on the Liquid Network in 2019. Liquid is a Bitcoin sidechain that enables fast and confidential Bitcoin transactions.
Tether Limited, a subsidiary of Hong-Kong based company iFinex, issued 36,561,500 USDT tokens on Liquid.
rDAI is a wrapped version of the Ethereum-based DAI stablecoin on Rootstock (RSK). DAI has a soft peg to the US dollar and is issued by DeFi protocol, MakerDAO. DAI is minted when a user locks up a digital asset as collateral in a vault on Maker. DAI uses smart contracts to maintain its peg, having a variety of crypto assets as on-chain collateral. It was released in 2017.
Rootstock users can move DAI from Ethereum to RSK and vice versa using the Token Bridge, which was rolled out in 2020. DAI tokens are locked on the Ethereum blockchain, and an equal amount of rDAI tokens are minted on RSK during the bridging process. rDAI tokens are burned, and DAI is released on the Ethereum blockchain to redeem DAI.
rDAI was created in 2020. It has a total supply of 301,620, according to the RSK explorer.
Stablecoins Use Cases in the Bitcoin DeFi Market
Now, let’s take a look at how you can use Bitcoin stablecoins in the growing Bitcoin DeFi ecosystem.
First and foremost, Bitcoin stablecoins are used as trading capital to move in and out of risky assets in the DeFi markets. For instance, using the ALEX decentralized exchange, you can buy STX tokens with sUSDT (and vice versa) at any time to enter and exit a position in the STX token.
Lending & Borrowing
Arguably the most popular use case for stablecoins in DeFi is as a lending asset to earn interest. For example, you could rUSDT in a lending LP on the decentralized finance protocol Sovryn to earn yield.
On the other hand, users can put up their digital assets as collateral to mint and borrow stablecoins. For instance, you can mint and borrow USDA on the Arkadiko protocol by locking up your STX tokens. The locked (stacked) STX tokens could then earn investors a Bitcoin yield via Proof-of-Transfer, a consensus mechanism used on Stacks. The stacked (locked) STX tokens provide stability to the Stacks network. In return, stackers earn native BTC rewards.
Several Bitcoin DeFi protocols also enable you to stake Bitcoin-powered stablecoins to earn yield. Staking involves locking up a digital asset in a smart contract in exchange for staking rewards.
For example, at the time of writing, you can stake USDA to earn a double-digit annual yield on Arkadiko. You can access this DeFi protocol within just a few clicks using your Xverse wallet.
Yield farming allows investors to earn by depositing digital assets into a liquidity pool on liquidity protocols built on layer-2 Bitcoin networks. Liquidity pools are created by depositing two assets into a pool, one of which can be a stablecoin. Adding a stablecoin to an LP reduces risk to some degree, potentially increasing your earning potential as a yield farmer. Besides swapping and bridging tokens, you can yield farm by adding liquidity as a liquidity provider on ALEX using your Xverse wallet dApp Browser.
What’s Next for Bitcoin Stablecoins?
As the Bitcoin DeFi ecosystem continues to expand, we can expect to see a growth in the Bitcoin stablecoins market segment as the demand for “digital dollars” on Bitcoin will likely increase.
Is Bitcoin a stablecoin?
No. Bitcoin is not a stablecoin. A stablecoin is a digital asset whose price is linked to assets with a high degree of price stability, like fiat money and precious metals. Going by this definition, Bitcoin is not a stablecoin because its value is not tied to any other asset. As a result, Bitcoin experiences price fluctuations driven by supply and demand.
How stable are stablecoins?
Stablecoins are relatively stable, meaning they can trade at or very close to the target peg value. For instance, USDT can trade at $0.999, and it would still be acceptable even if this price is below the $1 peg value.
However, judging by history, various stablecoins have already dropped significantly below the pegged value. This event is called a depeg. Depegging could be caused by increased selling pressure, leading to a depegging if an issuer hasn’t maintained a sufficient amount of the reserve asset.
What are examples of a stablecoin?
Dollar on Chain (DoC), L-USDT, rDAI, Brazilian Digital Token (BRZ), Stably USD (#USD), sUSDT, and USDA are all examples of Bitcoin-based stablecoins. Each stablecoin has a different issuer, which maintains the peg using varying mechanisms. Some of them, as is the case with USDA, for example, are also based on smart contract technology.
The aforementioned Bitcoin-based stablecoins are all on layer-2 networks except Stably USD, which is a Bitcoin-native stablecoin. That means it’s minted directly on the Bitcoin base layer, while the other stablecoins are minted on Bitcoin layer-2 networks. Stably USD is a BRC-20 token created using Ordinal Theory.
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