Stablecoins Battle Royale: USDT vs USDC vs DAI

Stablecoins are among the key elements of the overall crypto ecosystem. They act as a major link between the cryptocurrency and fiat worlds, provide stability in the otherwise highly volatile crypto market, and serve an important role in the DeFi industry. As of today, the three largest stablecoins by market cap are the central entity-backed USDT and USDC and the algorithmically-maintained DAI. There are pros and cons as well as unique risks pertinent to each of these two stablecoin operation modes. In this article, we take a deeper look at the world’s top stablecoin assets and consider their peg maintenance modes.

As of 24 September, the top three largest stablecoins by market were Tether (USDT), USD Coin (USDC), and DAI. The trio is followed by TrueUSD (TUSD) and the Binance-supported BUSD.

USDT and USDC are stablecoin assets whose pegs to the greenback are backed by their issuing companies – Tether and the Centre Consortium, respectively. In contrast, DAI is a decentralised stablecoin whose functionality and dollar peg are algorithmically maintained based on the user activity on its host protocol – MakerDAO.

Let’s have a closer look at each of these stablecoins, with specific attention given to their proof of reserve practices. It is these practices that are critical for the transparency and security of their pegs to USD, an issue of paramount importance to any investor in stablecoins.

USDT is not only the top stablecoin by market cap but is also the most actively traded cryptocurrency, regularly surpassing Bitcoin by daily trading volumes. Much of the coin’s popularity is due to its “first mover advantage” – USDT is the oldest among the surviving stablecoins. It appeared on the market in 2014, when the concept of stablecoins was just being developed.

The market embraced USDT enthusiastically, and that early adoption continues to provide the coin with competitive leverage over its key rivals as of today.

USDT is issued and managed by Tether Limited, a company that has played a major role in the crypto space. Tether itself is owned by iFinex Ltd based in Hong Kong. Tether Limited claims to hold reserves equivalent to the total supply of USDT tokens in circulation. In other words, for every USDT token in circulation, there should be an equivalent amount of US dollars held in reserve. This one-to-one backing is intended to ensure that USDT remains stable and reliable.

Tether’s commitment to holding sufficient dollar reserves for USDT has often come under scrutiny. Firstly, even as of today, the company doesn’t conduct full regular audits of its reserves. Last year, it engaged the Italian arm of the BDO accounting advisory to carry out quarterly “opinion reports” on Tether’s reserves. These opinion reports are significantly less rigorous than full audits. Besides, the choice of the Italian auditing entity looks bewildering as Tether has no distinct connection to this country or any other EU member country.

Additionally, in the past, Tether was fined in the US for falsely claiming to have sufficient dollar reserves for each USDT in circulation.

USDC, short for USD Coin, stands as another significant player in the world of stablecoins. It’s the second most traded stablecoin after Tether’s USDT. Although significantly behind USDT in terms of trading volumes and market cap, USDC is often regarded as the more transparently maintained stablecoin. However, by the time USDC arrived on the scene in 2018, USDT had already been the default go-to stablecoin for the crypto trader community. Thus, historical reasons have ensured that USDT’s dominance continues as of today.

From USDC’s launch in 2018 until last month, the issuance and management of the stablecoin were overseen by a consortium known as the Centre Consortium, a collaboration between two companies –peer-to-peer payment services provider Circle and the Coinbase crypto exchange.

Circle is a fintech startup founded in 2013 in Boston and has a track record of providing innovative financial solutions in the digital space. Circle's role in the USDC ecosystem includes issuing and redeeming USDC tokens, ensuring that they remain fully backed by US dollars held in reserve.

The consortium’s other member – Coinbase – requires little introduction. It is the largest crypto exchange in the US and the second largest in the world, behind Binance.

In late August, Coinbase acquired a stake in Circle, which led to the dissolution of the Centre Consortium. The official statement says that Circle will be the sole entity responsible for USDC. In practice, this means that Coinbase, which now has a minority stake in Circle, also retains significant influence on the stablecoin.

The Centre Consortium has maintained much more rigorous and transparent audit and reserve proof practices for USDC than Tether has ever done for USDT.

Most of these audits concern Circle, the member of the consortium that has had a more active role in the management of the coin than Coinbase. Between 2019 and 2022, Circle was annually audited by Grant Thornton, a leading audit consultancy. These audits included certifying the USDC reserves. In early 2023, Circle announced the change of its primary auditor to Deloitte.

In addition to full yearly audits, Circle provides monthly attestations of its USDC reserves certified by a public accountant to the Securities and Exchange Commission (SEC).

DAI, often referred to as the "decentralised stablecoin," is a pioneering digital asset in the world of cryptocurrencies. DAI differentiates itself from its stablecoin counterparts, such as USDT and USDC, by being decentralised with regards to its functionality and peg maintenance. Instead of relying on a centralised entity to maintain its stability, DAI's value is upheld through smart contract mechanisms and collateralised assets on the MakerDAO platform – one of the leading DeFi protocols based on Ethereum (ETH).

DAI is therefore an algorithmically-maintained stablecoin. It maintains a “soft peg” to the USD, which means that its value might slightly fluctuate around the $1 mark, depending on the crypto borrowing and lending activity on the MakerDAO protocol.

Technically speaking, the MakerDAO protocol and the user community on the platform are behind the stablecoin. However, there is no centralised owner for DAI, something that many decentralisation purists often point out when the coin is compared with the likes of USDT or USDC.

DAI achieves its peg stability through a unique and decentralised mechanism on MakerDAO:

· Collateralisation. DAI is generated by users who lock up collateral crypto assets, such as Ethers, in a smart contract called a "Vault". These collateral assets are held as security to ensure the value of DAI.

· Overcollateralisation. Users must deposit more collateral than the value of the DAI they wish to create. This overcollateralisation acts as a safety net, reducing the risk of DAI instability.

· Autonomous Control. The MakerDAO community governs DAI's stability by voting on various parameters, including the collateral types accepted and the stability fee (interest rate). This decentralised governance should, in theory, ensure that DAI remains secure and stable.

· Decentralized Price Oracle. To maintain its peg to the US dollar, DAI relies on decentralised price oracles that provide real-time price data from external sources. This data is used to calculate the collateralisation ratio.

To an investor unfamiliar with the world of DeFi, DAI’s peg maintenance mechanism might sound quirky and prone to imminent failures. While DAI has had very brief peg instability moments in the past, in general, the coin has managed to maintain its close peg to USD remarkably well for the last nearly 6 years it has been on the market.

Many investors are rightfully concerned that stablecoins like USDT and USDC, backed by private companies, rely on these companies’ reserves and ability to maintain the pegs. This doesn’t mean, however, that algorithmic, decentralised stablecoins like DAI are inherently safer. In fact, DAI and similar decentralised stablecoins rely on an intricate peg maintenance mechanism that is far from being 100% fault-proof.

Many crypto projects with decentralised stablecoins have failed over the years. The most prominent of these is the UST stablecoin on the Terra blockchain, whose peg to the greenback collapsed in May 2022, leading to the project’s bust. Thus, the case of DAI and its successful, nearly 6-year-old peg maintenance mechanism might simply be the case of a survivorship bias. In other words, DAI is a rare survivor among the many algorithmic stablecoin projects attempted over the years.

Naturally, the current market success of USDT and USCD might also be examples of the same survivorship bias, given that the history of the crypto industry features many centralised stablecoins that have gone bust.

Thus, both centrally-backed and algorithmic stablecoins have non-trivial security risks associated with them. At the same time, the leading stablecoins remain popular as they act as important oases of rate stability - USDT and USDC for payments and value store and DAI for DeFi operations - in a market known for its extreme volatility.