Better Stablecoin Buy: Tether (USDT) vs. Dai (DAI)

Over the past decade, a growing number of stablecoins have emerged as more conservative alternatives to volatile cryptocurrencies. Most stablecoins are pegged to the U.S. dollar, can be held without a bank account, used for faster, cheaper cross-border money transfers, and staked for higher yields than traditional savings accounts. They can also help people preserve their savings in countries facing hyperinflation and currency devaluation issues.

The world's most valuable stablecoin is Tether (CRYPTO: USDT), launched in 2014 and currently with a market cap of $187 billion. However, it faces fierce competition from smaller stablecoins like Dai (CRYPTO: DAI), launched in 2017 and valued at $5 billion.

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It might seem pointless to compare Tether to Dai, since both stablecoins trade at $1.00 and are pegged to the U.S. dollar. However, these two tokens are fundamentally different, with distinct strengths and weaknesses. Let's see which coin is the more "stable" play for the future.

The similarities and differences between Tether and Dai

Tether was initially minted on Omni Layer, a smart contract-enabled protocol that runs on top of Bitcoin's (CRYPTO: BTC) blockchain. It was subsequently minted as an ERC-20 token on Ethereum's (CRYPTO: ETH) blockchain, then minted across other smaller blockchains.

Tether Limited, a subsidiary of Hong Kong-based iFinex (which also owns the Bitfinex cryptocurrency exchange), is the only company that mints or burns Tether tokens.

Dai was initially minted as an ERC-20 token on Ethereum, and it hasn't spread to other blockchains yet. It's a decentralized token which can only be minted via a smart contract when a user deposits an approved crypto asset -- such as Ether or Wrapped Bitcoin (CRYPTO: WBTC) -- which is worth more than the value of the minted Dai into a "Maker Vault". That premium, known as a "stability fee," acts as a buffer against the volatility of its underlying collateral.

Neither token is directly backed by U.S. dollars or Treasuries. Tether uses an opaque mix of cash, commercial paper, and other assets to maintain its peg to the U.S. dollar. Dai relies solely on approved crypto assets across its Maker Vaults to stay pegged to the U.S. dollar.

Those strategies make Tether and Dai riskier than more conservative stablecoins like USD Coin (CRYPTO: USDC), which is directly backed by U.S. dollars and Treasuries on a 1:1 basis. However, they're also less exposed to government interference because they're not heavily dependent on actual U.S. dollars. Instead, they're "synthetic" dollars, which merely reflect the market value of the U.S. dollar without holding all that cash.

Which stablecoin is riskier?

Tether and Dai both have their distinct risks. Tether is centralized, and its future depends entirely on Tether Limited's ability to keep minting or burning more tokens. If you trust Tether, then its stablecoin could be an excellent long-term investment.

However, it relies solely on third-party attestations of its underlying reserves rather than opening its books to complete audits. Its reserves are stored off-chain, so they can't be freely audited by its investors.

That lack of financial transparency -- along with its controversial ties to China -- could increase its long-term risks. Its centralization under a single company also exposes it to more regulatory challenges than decentralized tokens, and it can censor, freeze, or blacklist its own accounts.

Dai is decentralized across its Maker Vaults, so it isn't dependent on a single company or heavily exposed to tighter regulations. The real-time value of those collateralized vaults is fully visible to the public, which eliminates the need for traditional audits. However, its price could still crumble if another crypto winter reduces the value of the collateral stored in those vaults.

The better stablecoin buy: Dai

Tether and Dai should both stay pegged to the U.S. dollar while generating attractive staking yields on centralized finance (CeFi) exchanges and decentralized finance (DeFi) pools. Nevertheless, Dai's decentralized approach, financial transparency, and lack of direct exposure to China should make it a more attractive stablecoin than Tether this year.

Leo Sun has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Bitcoin and Ethereum. The Motley Fool has a disclosure policy.