Top three reasons the Cardano blockchain may need a stablecoin backed by dollars

Authored by: Keisha Dwyer - EMURGO

Acknowledgments: Tyler Wales - EMURGO

Originally published on emurgo.io: October 24, 2022

Why stablecoins?

The Cardano blockchain is an open-source and decentralized blockchain platform driven by a research-first approach. Cardano is considered to be one of the biggest environmentally-friendly blockchain networks in the industry due to its algorithm.

Ada, the native cryptocurrency to Cardano, was developed to provide permissionless financial access to anyone and everyone. To date, there are more than 3.9 million active ADA wallet addresses signaling its global reach. However, the price volatility of ADA, and other cryptocurrencies in general, potentially restricts users from taking full advantage of the permissionless and global nature of Cardano, such as not being able to use crypto assets as a store of value or medium of exchange.

Some people believe that the solution to this problem is stablecoins, digital currencies that are pegged to a US dollar or other fiat currency.  Because stablecoins are backed by a safe asset, like the dollar, this should contrast cryptocurrencies that aren’t backed by anything and lead to wild price fluctuations. 

For more on stablecoins and the different stablecoin approaches see Stablecoins: What Are They, and How Do They Work?

For this blog, we’ll focus on stablecoins backed by dollars and provide reasons why Cardano may need this stablecoin approach. But first, a little more on stablecoins backed by dollars, otherwise known as fiat collateralized stablecoins.

Fiat collateralized stablecoins

According to Cardano Clan, with a market cap of $130B+, stablecoins backed by dollars are the most dominantly-used stablecoins making up almost 90% of the existing stablecoins in the market today. Some of the most popular stablecoins of this type are Tether tokens (USDT), USD Coin (USDC), and Binance USD (BUSD). Fiat-collateralized stablecoins are fully backed by cash or cash equivalents and maintained by centralized issuers like Tether or Circle. These issuers are audited regularly to ensure the integrity of the reserves.

As smart contracts and DeFi on Cardano grows, a stablecoin backed by dollars could be well suited to become one of the most important tools for our ecosystem. Let’s unpack some of the reasons why.

Top 3 reasons Cardano may need a stablecoin backed by dollars

1. Dollar reserve-backed stablecoins could build Cardano investor confidence

Not all stablecoin designs are made equal. A fiat-backed stablecoin losing its peg has a higher probability of returning 1:1 to its paired asset. A Cardano stablecoin backed by dollars can be said to be a more reliable approach than an algorithmic design, which is not backed by “real-world” assets.  The integrity of a stablecoin approach backed by dollar reserves could create a strong price stability assurance for the Cardano community and improve Cardano investor confidence.  This is especially true during periods of sudden volatility.  Temporary price deviations from the peg during extreme market downturns would spook the Cardano investor less since a stablecoin backed by dollars would in theory come back to the peg once the market stabilizes.  

2. Stable financial service offerings for ADA holders

One main goal of stablecoins on Cardano is to facilitate trades.  A USD-denominated stablecoin that could maintain its peg better - on demand - would offer a better long-term approach to stability and store of value for the Cardano ecosystem.  One result would be the unlocking of even more reliable financial services to the Cardano ecosystem such as stable lending and swapping.

3. The future of algorithmic stablecoins has gotten more uncertain since the LUNA collapse

Because every approach has strengths and weaknesses, maintaining a balance towards stablecoin approaches is key. When choosing a stablecoin for the Cardano ecosystem, it is important to consider vulnerabilities and looming global stablecoin regulation.  The LUNA collapse in May 2022 laid the groundwork for stricter regulation of algorithmic stablecoins and the future of this approach is uncertain, particularly in the United States.  For an algorithmic stablecoin on Cardano like Djed, several countries, including the USA, will likely not have access to its platform at launch. 

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