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Stablecoins play an essential role in decentralized finance (DeFi). While other cryptocurrencies fluctuate wildly, stablecoins are pegged to a specific value or asset, usually the U.S. dollar.
For example, one USDT, aka “Tether,” is designed to equal the value of one USD. This enables stablecoins to become units of accounts and a solid medium of exchange in the volatile world of crypto.
Users need stablecoins as on-ramps into DeFi: They allow users to borrow, lend, earn interest, issue payments, and participate in other financial services in a stable, predictable way.
Despite having on-ramps, DeFi has failed to garner large-scale institutional adoption despite having relatively high interest rates. There is a demand for access to DeFi by retail investors, so why are institutions so slow to provide it? Findora believes it is because stablecoins are missing a key ingredient – privacy.
Combining the best stablecoins with privacy is necessary to building the neutral rails needed for any financial system. The best stablecoins would be not only stable, but private and auditable.
Before delving into what the best stablecoins in the future will be, it’s important to understand what stablecoins have been.
What Are Stablecoins?
Stablecoins are a type of cryptocurrency whose value doesn’t change, but instead is pegged to a certain asset or value. Because their price doesn’t change, they can be used like cash in the world of cryptocurrencies and DeFi.
Stablecoins are classified by how they maintain their pegs. Though many types of stablecoins exist, there are two main categories: algorithmic or collateralized stablecoins.
Algorithmic stablecoins, as the name suggests, use complex mathematical algorithms to keep their pegs. Examples include UST and FRAX. The main advantage they offer is in being truly decentralized and permissionless. If the coin is controlled only by code, not some central authority, then people can’t be banned from using it and their funds can’t be frozen.
As this beginners’ guide to stablecoins from Hackernoon states: “Algorithmic stablecoins use an algorithm underneath which issues more coins when price increases, and buys them off the market when the price falls.”
These automated buying and selling actions are meant to control the supply and demand to keep the price static. However, no algorithmic stablecoin has worked at scale. UST was one of the largest and most ambitious algorithmic stablecoin projects, backed by the Terra/Luna ecosystem. After UST lost its peg, the coin’s value plummeted to zero in just a few days, and the entire ecosystem supporting it collapsed.
Many people have consequently speculated that a truly algorithmic and decentralized stablecoin is not possible. The far more stable option is a collateralized stablecoin.
Collateralized stablecoins are backed by some sort of asset, whether that is the U.S. dollar, other cryptocurrencies, commodities, financial instruments, or a mix of these.
An example of a crypto-backed stablecoin is DAI. DAI, issued by MakerDAO, is backed by ETH held in smart contracts. However, since the price of ETH is volatile, the value of ETH held must be significantly more than the amount of DAI issued. Crypto-backed stablecoins are more decentralized than fiat-backed stablecoins but also cost more to collateralize.
Another example of a collateralized stablecoin is fiat-backed stablecoins, like USDT and USDC. In theory, there is a 1:1 ratio to fiat currency held and stablecoins issued, so that to issue $1 billion in USDT or USDC, the issuing agency would need to hold $1 billion in USD.
The three largest stablecoins, USDT, BUSD, and USDC are all fiat-backed, signaling the market trusts centralized and collateralized coins above all others.
Why The Best Stablecoins Need Privacy
Perhaps the biggest problem with all stablecoins is that they have no privacy. Every transaction is public, and all transaction data is visible on open ledgers, including the amount, token type, and wallet addresses used.
This makes existing stablecoins unsuitable for basic functions like:
Employee or contractor salaries
Trading companies don’t want to expose their strategies by making token movements public. Businesses would give up competitive secrets by making their transactions public, as well.
In addition, financial services companies can’t comply with regulations if they are not able to protect customer transaction data. The ability to investigate fraud and money laundering protects consumers and developers who don’t want to find their projects suddenly sanctioned by a regulatory body. Since regulatory compliance will be a necessary part of mass adoption, Findora’s ability to combine privacy with auditability is an important innovation.
Findora’s FIP-2 Will Offer Privacy Plus Auditability
Findora is a leading privacy project in Web3 combining blockchain technology and zero-knowledge proofs to create a protected ledger system. In a recent improvement proposal called FIP-2, Findora has dramatically advanced its goal of making stablecoins private yet auditable, so they can have the same utility as digital cash has now.
According to Findora: “Despite massive global growth as an industry, the reality is that DeFi has barely scratched the surface. The one thing keeping institutional capital from entering the DeFi market en masse is privacy. From masking transaction details to shielding account balances to protecting confidential business intelligence and individual user identity, these are the areas where Findora will leave its mark on the DeFi market.”
Currently, when a user sends stablecoins using a public blockchain like Ethereum, the transaction is visible on the open ledger. Everyone can see the stablecoins leave your “wallet” and land in someone else’s.
Findora is creating a blockchain system that leverages a protected ledger. It would allow for users to have the same privacy they do now when sending cash to others with traditional bank accounts. Findora does this through zero-knowledge proofs, an advanced cryptography technique that allows data to be verified without being exposed.
With FIP-2, stablecoin issuers like Circle, MakerDAO, or other institutions would be able to audit transactions involving their tokens, though those movements would not be visible publicly on-chain.
APPAs could help these institutions identify blacklisted tokens to protect users, and even prevent blacklisting in the first place. Because transactions can be audited, these institutions could comply with regulations and aid in necessary investigations into criminal activity, preventing a Tornado Cash-style sanction.
Discreet Labs CEO Warren Paul summed up the benefits of this approach when he recently noted: “I’ve seen rhetoric … regarding crypto privacy but few proposed solutions. FIP-2 for Auditable Privacy-Preserving Assets is one proposed solution for Findora. A first-of-its-kind feature that allows asset issuers to view transaction history while preserving user privacy.”
The views and opinions expressed in this article are solely those of the authors and do not reflect the views of Bitcoin Insider. Every investment and trading move involves risk - this is especially true for cryptocurrencies given their volatility. We strongly advise our readers to conduct their own research when making a decision.