Decentralized Stablecoins and Crypto Savings Accounts

Wondering about decentralized stablecoins and crypto saving accounts? This article aims to shed some light on those very subjects! Let’s dig in. 

Stable coins are crypto tokens that are pegged to fiat currencies. They’ve been around since 2014. Some examples of these include Tether (USDT), Coinbase’s US Dollar Coin (USDC), and Gemini’s Gemini US Dollar (GUSD). These coins allow users to transfer fiat currency from one person to another using a standard crypto wallet. This increases the security of fiat transactions and sometimes lowers transaction fees. 

In the past, all stable coins had an element of centralization and were issued by institutions and required users to trust these institutions. For example, users of USDC needed to trust Coinbase to redeem USDC for actual US dollars. If for some reason, Coinbase were to stop redeeming tokens, these tokens would have become worthless. But this has changed recently with the introduction of decentralized stable coins such as DAI. 

DAI – A DECENTRALIZED STABLE COIN

DAI is a stable coin pegged to the US Dollar. But it is not issued by a company the way USDC, Tether, or GUSD is. Instead, DAI price stability is maintained through a complex mechanism that works similarly to a collateralized debt obligation (CDO). 

Here is how it works. 

CREATING DAI

Each user is allowed to mint his own DAI after depositing a certain amount of ETH to the DAI smart contract. The minimum amount of ETH needed is $150 worth of ETH per 100 DAI minted. Most users deposit much more than the minimum amount. 

The DAI issued to the user can be thought of as a “debt” and the ETH deposited as “collateral”. 

DESTROYING DAI

Once a user has been issued DAI, he can “pay off the debt” by sending DAI back to the smart contract. In this case, the DAI gets burnt (destroyed) and the ETH deposit is released back to the user’s wallet. 

LIQUIDATION

The DAI system needs to make sure there is enough ETH collateral to back all of the DAI that has been issued. To do this, it partially liquidates accounts that have collateral valued at less than 150% of DAI issued. If this happens, some of the ETH held as collateral is swapped for DAI, and the DAI is burnt. This reduces the DAI debt until the ratio is back to 150$ worth of ETH collateral per 100 DAI. 

HOW THE PEG IS MAINTAINED

If users believe that the USD price of ETH will rise in the future, they have an incentive to issue (borrow) DAI and use it to buy more ETH. This increases the supply of DAI, pushing down its dollar price. On the other hand, if users believe the dollar price of ETH will fall, they have an incentive to sell ETH for DAI and pay the DAI back to the contract. This reduces their debt/collateral ratio. It also decreases the supply of DAI and pushes up its price. DAI has proven to be fairly stable when compared to traditional cryptocurrencies like BTC or ETH. And it has done so without requiring users to trust a central entity holding USD in a bank account. 

CENTRALIZED EXCHANGES

Since the early days of crypto trading, investors and traders have used centralized exchanges to swap one coin or token for another. Centralized exchanges are exchanges that require users to give up custody of their crypto in order to make a trade. Examples of centralized exchanges include Coinbase, Binance, and Kraken. 

Let’s say that a user wants to swap ETH for DAI using Binance, for example. The user must first deposit his ETH into a Binance account. Once he does this, Binance holds the private key to his crypto and therefore has physical control over it. 

In the early days of crypto trading, investors were often happy to deposit their crypto into these exchanges – since doing so was far more convenient than using message boards and escrow systems to trade. But these exchanges also came with a lot of hassles. To fulfill KYC/AML requirements, users needed to submit picture IDs using smartphone apps that sometimes didn’t work. 

And even after being approved, users often faced temporary withdrawal holds, minimum or maximum withdrawal amounts, and other obstacles to safely and securely withdrawing their crypto. Despite these drawbacks, crypto traders had no other option but to use centralized exchanges until recently. 

DECENTRALIZED EXCHANGES

Today, decentralized exchanges provide another option. Here is how they work. Let’s say that a user wants to swap ETH for DAI. He sends his ETH to a smart contract on the Ethereum network. No centralized entity gets access to these funds, so no one can place a hold on withdrawals. 

Meanwhile, the exchange contract sends out a request for prices from all of the reserve pools in the network. These pools are themselves smart contracts not under the control of any individual or group. When the exchange contract finds the lowest price for DAI, it sends a request to the relevant reserve pool. The reserve pool then sends DAI to the exchange contract. 

Once both coins are received, the contract sends the user’s ETH to the reserve pool and the reserve pool’s DAI to the user. All of this occurs using a standard Ethereum wallet, and most coins are capable of being swapped in less than a minute. The user’s funds are never put into the possession of a central authority that could place holds on it. As a result, users can swap one token for another without the hassles associated with centralized exchanges. 

SYNTHETIC ASSETS

Another essential product in the DeFi market is synthetic assets. Synthetic assets are crypto tokens pegged to real-world assets through debt collateralization. 

Synthetic assets can represent commodities like gold, silver, oil, or copper, other cryptocurrencies, or even stocks like APPL or GOOGL. Synthetix is an example of a synthetic asset platform. On Synthetix, users can transfer a token called SNX to a smart contract and mint new tokens called synths. These synths can represent a wide variety of real-world assets, including any major cryptocurrency, the Japanese Yen, the FTSE index, and others. These tokens are minted using a collateralized debt system similar to DAI. 

Users place a certain minimum USD value of SNX into a smart contract. In exchange, they are allowed to mint tokens representing a real-world asset. The newly minted synth creates a debt for the user, while the SNX held in the contract is considered collateral. 

Users place a certain minimum USD value of SNX into a smart contract. In exchange, they are allowed to mint tokens representing a real-world asset. The newly minted synth creates a debt for the user, while the SNX held in the contract is considered collateral. 

As with DAI, synths do a fairly good job of maintaining a peg to the assets they represent. 

COMPOUND – CRYPTO SAVINGS ACCOUNTS AND LOANS

While decentralized stable coins, decentralized exchanges, and synthetic assets represent the foundations of DeFi, crypto savings accounts and loans can be thought of as its ultimate purpose. The compound is the most popular crypto savings and loans platform today. It allows users to earn interest on their crypto or use crypto as collateral to borrow other crypto. The Compound decentralized app (Dapp) is located here. The saving/lending functions are listed on the left side of the screen, and the borrowing functions are on the right side. 

METAMASK AND WEB-3 WALLETS

The compound is a Web-3 application. Users can connect to it using a Web-3 wallet such as Metamask, Coinbase Wallet, or Ledger. Metamask is the most popular Web-3 wallet. It’s a browser extension for Chrome, Firefox, and Brave. It can be downloaded from the official Metamask download page. 

CREATING A CRYPTO SAVINGS ACCOUNT

Crypto savers can use Compound to create a saving account in a variety of cryptocurrencies, including Basic Attention Token (BAT), DAI, USDC, Wrapped Bitcoin (WBTC), and others. 

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Enabling is a transaction on the Ethereum network and incurs a transaction fee just like any other. Second, the user clicks the token and enters the amount he wants to transfer to the Compound smart contract. After entering the amount, he clicks supply to send the transaction to Metamask. 

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Once the transaction is confirmed on the Ethereum network, the tokens will be shown in a special section at the top-left of the page, confirming that they are in the smart contract and no longer in the user’s wallet. 

From that moment on, other users will be able to borrow these tokens by pledging different tokens as collateral. The user who owns the tokens will earn interest on these loans. The interest rate is shown under APY/Earned in the token listing. 

As with other DeFi apps such as DAI or Synthetix, borrowers whose collateral value falls below a certain percentage of the outstanding loan balance will have some of their collateral confiscated to pay off the debt. This should help to ensure that loans get repaid. 

However, savers should keep in mind that these “loans” are not F.D.I.C. ensured. So if some rare, “black swan” event wipes out the value of the collateral, the saver could lose everything in the account. 

BORROWING CRYPTO

Should a user want to borrow tokens, they must first deposit a different token into the account to use as collateral. For example, if a user wants to borrow DAI, they may want to deposit ETH into the account or vice-versa. Once the collateral token is deposited, the user can borrow a different token by clicking it on the right side of the screen. This brings up a popup window where the user can enter how much of the token he wants to borrow. When the user clicks borrow, the tokens are sent to his wallet. 

In Short

This was an in-depth explainer about assets and crypto-saving accounts. For more information on Decentralized Finance, check out some of our other investor guides

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