$CST and how Stablecoins work

In the context of PulseChain, stablecoins play a crucial role in providing a bridge between the volatile cryptocurrency market and the stable value of fiat currencies. The terms “bridged stablecoin” and “native stablecoin” refer to the origins and operational mechanisms of these stablecoins within PulseChain. Understanding the distinction between the two is essential for grasping how they maintain price stability and integrate with third party tools.

Types of Stablecoins

The PulseChain ecosystem currently has 5 Stablecoins.

Native Stablecoins

A native stablecoin is a type of stablecoin that is issued directly on its own blockchain or a blockchain where it is primarily designed to operate. These stablecoins are created and managed by a protocol or organization within the ecosystem of their primary blockchain.

The term “native” signifies that the stablecoin is an integral part of the blockchain’s ecosystem, optimized for its infrastructure, and usually benefits from direct support in terms of security, efficiency, and compatibility.

There are two stablecoins that are ‘native’ to PulseChain:

CST
USDL

Bridged Stablecoins

A bridged stablecoin, on the other hand, refers to a stablecoin that originates on one blockchain but is made available on another through a process known as “bridging.” Bridging involves the creation of a token on a secondary blockchain that represents the original stablecoin. This is often done to take advantage of the unique features of different blockchains, such as lower transaction fees, faster processing times, or enhanced smart contract capabilities. Bridged stablecoins maintain their peg to the original stablecoin value but operate on a different blockchain.

The process typically involves locking up the original stablecoin in a smart contract on its native blockchain and then minting an equivalent amount of the bridged stablecoin on the target blockchain. This process can be reversed to redeem the original stablecoin.

There are three stablecoins on PulseChain that have been ‘bridged’ from Ethereum:

eUSDC
eDAI
eUSDT

Key Differences

1. Issuance and Operation: Native stablecoins are issued within and designed to operate primarily on their original blockchain, whereas bridged stablecoins are issued on one blockchain and then bridged or ported to operate on another.
2. Integration and Efficiency: Native stablecoins are generally more tightly integrated with their blockchain’s infrastructure, potentially offering better security and efficiency. Bridged stablecoins, while versatile, may depend on the reliability and security of the bridging mechanism.
3. Purpose and Utility: Native stablecoins often serve as a foundational element of their blockchain’s ecosystem, facilitating transactions, lending, and other DeFi activities. Bridged stablecoins extend the utility of existing stablecoins to new ecosystems, promoting interoperability between blockchains.

Pegging an Asset

It’s important we are all familiar with how stablecoins work – or how they trade at (or near) $1. There are multiple factors that allow stablecoins to maintain their “peg”:

The three most important factors are:

Redeemability
Liquidity
Arbitrage

Redeemability

The most important factor is “redeemability” as it allows for arbitrage (discussed below). In the case of $CST allows a user to burn $CST and receive $USD in their digital bank account at a ratio of 1:1 (less a small fee). The fact that $CST is always redeemable for one dollar allows for arbitrage to occur and the “pegging” of $CST to $1.

Liquidity

Although they can be Minted and Burned on the Coast dApp, $CST and other PulseChain assets trade exclusively on decentralized exchanges (with the majority of LP on PulseX and PHUX). The prices of assets being traded on DEXs are determined by the ratio of those assets within liquidity pools and is governed by the mathematics of automated market makers.

For example, when you swap $CST for $PLS you are adding $CST to the liquidity pool and removing $PLS which causes the price of $PLS to rise (as it is more scarce within the pool).

Conversely, the price of $CST actually falls (sell pressure) as it is becoming more abundant within the liquidity pool – no stablecoin is immune to this. As liquidity becomes ‘deeper’ and stableswap pools (such as the balancerV2 fork available on PHUX) reduce these effects.

If you’re a DeFi investor, it is critical you understand how an automated market maker (AMM) works, start with this simple tutorial:
“Whiteboard Crypto”: What is an Automated Market Maker? (Liquidity Pool Algorithm).

Arbitrage

Arbitrage is the practice of buying and selling the same or similar asset in different markets to profit from price differences. In the context of stablecoins, it would involve buying $CST below $1 and redeeming it for $1 at our dApp to profit from the spread.

Buying the $CST on-chain (to facilitate arbitrage) makes it less abundant in the liquidity pool and raises the price. This is profitable while $CST trades below $1. Additionally, if $CST is trading above $1 it can be swapped (and thus sold) for other stablecoins for profit, which reduces the price. Effective arbitrage is the sole reason a stablecoin remains on its “peg”.

Summary

Stablecoins play an important role on all DeFi networks and as users it is critical you have a solid understanding of all aspects of their function. We are hoping to see a third native stablecoin on PulseChain in late Q1 or Q2 – $PXDC – pretty impressive!

Stay safe out there.

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