Stablecoins are digital currencies that maintain a fixed value. They are designed to function like fiat currencies that exist on the blockchain. This brings with it several benefits in terms of usability, speed, and regulatory compliance. There are several different types of stablecoins, each defined by the mechanism used to maintain their 1-to-1 peg to their respective fiat currencies.
What Is a Stablecoin?
Stablecoins are digital coins that maintain a stable value. Most stablecoins are pegged to popular fiat currencies like the US Dollar, Chinese Yuan, or the Euro. Some are pegged to commodities like gold, too. In theory, a stablecoin could have its value linked to anything—however, coins pegged to a fiat currency are the most commonly used type. When someone uses the term “stablecoin,” they are most likely referring to fiat currency coins.
The most stable cryptocurrency will by definition be a stablecoin. Some of these coins see their values fluctuate by small amounts during times of intense trading volume, but they tend to correct back to their normal value in short order.
If there is any volatility in a stablecoin, it’s certainly much less than that seen in other different types of cryptocurrencies.
What Is the Point of a Stablecoin?
Stablecoins have a variety of benefits and uses. The main idea is to have a cryptocurrency that isn’t subject to the volatility of currencies like Bitcoin and the many hundreds of altcoins.
Beyond that, there are other benefits that make using a stablecoin preferable to using regular fiat currency in some situations. Some of the most commonly cited reasons for the creation and use of stablecoins are:
• Regulatory compliance for crypto exchanges
• Utility in decentralized finance (DeFi)
• Ease of use for traders
• The ability to make fast cross-border payments with low fees
Let’s look at each of these in detail.
Stablecoins Make Things Easier for Exchanges
With stablecoins, cryptocurrency exchanges get to sidestep the complex financial regulations involved with institutions that deal with fiat currencies. (Crypto regulations are very different.) This gives their users the convenience of having stablecoin trading pairs while keeping everything within the cryptocurrency ecosystem.
Stablecoins Are Essential to Decentralized Finance (DeFi)
Stablecoins are also becoming a necessary component of the DeFi space. Transactions like peer-to-peer lending, where people make direct loans to each other via blockchain, can be done with stablecoins.
Some users might prefer this option to other cryptocurrencies, which could hurt their rate of return if the price goes down. A stablecoin adds an element of predictability to financial arrangements.
Stablecoins Make Trading Easier
One group of people who often use stablecoins to their advantage are cryptocurrency traders.
When moving money between multiple volatile cryptocurrencies, holding onto profits can be difficult. While traders can always put their gains into Bitcoin (BTC), the largest cryptocurrency by market cap, it also has bouts of volatility.
Stablecoins provide an easy solution to this problem. Traders can simply move into a stablecoin like USD Coin (USDC) or Tether (USDT) to immediately lock in gains. Or, they can take advantage of arbitrage opportunities when the same cryptocurrency has a different price on two different exchanges.
Crypto exchanges have begun offering more stablecoin/altcoin pairs to make things easier for traders.
For example, rather than having to sell Cardano (ADA) for BTC and then sell BTC for USDT, a trader could simply trade the ADA/USDT pair and go directly into that stablecoin, if the ADA/USDT pair is provided. (These coins were chosen at random for the sake of explaining a concept).
Stablecoins Enable Fast, Cheap Cross-border Payments
Traditional bank transfers typically take anywhere from 3–5 business days and can cost anywhere from a few dollars to a few dozen dollars. International transfers tend to be the most expensive.
Stablecoin transactions can confirm within minutes or less at very little cost. Two people with stablecoin wallets can transact with each other from anywhere in the world at any time without the need for a bank or other third-party intermediary.
Different Types of Stablecoins
There are four types of stablecoins:
Centralized Coins Backed by Fiat Currency
The most popular stablecoins today use a centralized model and the back new token issues with fiat currency at a 1-to-1 ratio. US Dollar Coin (USDC) and Tether (USDT) are examples of this type of coin. In terms of real daily trading volume, USDT and USDC were the #1 and #6 most-traded cryptocurrencies, respectively, at the time of writing, according to data from Messari.
Decentralized Coins Backed by Cryptocurrency
Some other stablecoins that use a decentralized model, like DAI, have grown in popularity in the crypto community. Rather than maintaining their stable value through fiat reserves, users can lock up cryptocurrency as collateral for borrowing DAI on the Maker DAO platform. There are also a growing number of decentralized lending platforms that allow users to deposit DAI or other stablecoins and earn interest. Network consensus, rather than a centralized team, governs DAI (similar to how bitcoin works), which maintains a value equal to one US dollar.
Decentralized Algorithmic Coins
Decentralized algorithmic coins are a newer technology and differ from the other types of stablecoins in that they don’t involve any type of collateral backing. Instead, they rely on smart contracts to maintain their price.
Stablecoins Backed by Non-Currency Assets
There are also stablecoins backed by other assets, like gold. The overall functions remain the same, but the value is tied to the current price of gold, and physical gold would be used as collateral.
Are Stablecoins a Good Investment?
A stablecoin retains the same value as another asset, most often a fiat currency, so asking if stablecoins are good investments is like asking if cash is a good investment.
Stablecoins might be best thought of as tools for use in an emerging decentralized financial (DeFi) system rather than investments. These coins let traders and users of DeFi apps interact with a form of fiat currency directly on the blockchain. Stablecoins are an integral part of how DeFi works.
Benefits of Stablecoins
Stablecoin holders can use their stablecoins without access to a bank account, increasing access to financial services for some people. These coins also benefit from the security of blockchain.
One way stablecoins could be used as an investment is to earn interest on them. Some crypto exchanges and lending platforms offer higher interest rates on stablecoin deposits than most banks do on cash deposits.
Drawbacks of Stablecoins
Stablecoins also don’t have the same consumer protections in place that traditional banks do. Users will have to hold their stablecoin balance via any number of crypto storage methods and the cryptocurrency wallet of their choice.
Recommended: What Is a Cryptocurrency Wallet?
Critics have cited a potential lack of transparency regarding their asset reserves of stablecoins. In other words, it can be difficult to know whether or not the company behind the coin actually holds one dollar for each dollar-backed stablecoin.
The Most Popular Stablecoins
There are a handful of stablecoins that make up the lion’s share of market cap for this particular type of digital asset. Here is a short list of stablecoins that dominate the market.
DAI is a decentralized stablecoin governed by the Maker Protocol and its smart contracts, which in turn is governed by a community of MKR token holders. Over 400 apps and services have currently integrated DAI.
Tether (USDT) is the most popular stablecoin in terms of daily trading volume and the third largest cryptocurrency by market cap at the time of writing according to Coinmarketcap.com.
Tether is a fiat-collateralized stablecoin that trades on most cryptocurrency exchanges. In fact, as of February 2021, the majority of Bitcoin trading utilizes USDT.
Tether Ltd., the company that runs Tether, has come under controversy in the past for allegedly being hacked and losing $31 million worth of Tether coins. There was also an incident in 2019 involving iFinex Inc, which both operates the Bitfinex exchange and also happens to be the parent company of Tether Ltd. Bitfinix allegedly lost $850 million in client funds and used $700 million of Tether’s reserves to cover the gap.
Diem, formerly known as Libra, is the stablecoin project created by Facebook. The coin will have backing in dollars in a manner similar to Tether. Unlike most other stablecoins, Diem has its own blockchain.
Diem will be programmable, like Ethereum, so that developers can create their own decentralized applications on the Diem blockchain. This blockchain uses its own smart contract language called Move. Diem is undergoing testing as of the time of writing and plans to launch sometime later in 2021.
USD Coins (USDC) is backed by real dollars stored at financial institutions. Monthly audits are conducted to ensure that each dollar backing each coin is accounted for on record. This helps to maintain the 1:1 relationship between USDC and the US dollar. Like many other stablecoins, USDC runs on the Ethereum blockchain.
What’s the Most Stable Cryptocurrency?
Theoretically, any stablecoin should be stable, and most of them tend to see their values fluctuate by no more than 1% or 2% daily. The decentralized and algorithmic coins have historically seen somewhat more volatility than the centralized coins.
Stablecoins are cryptocurrencies that keep their value stable in relation to another asset—most commonly, an existing fiat currency such as the US Dollar.
Issuing these coins on a permissionless blockchain removes the barriers to entry associated with banks and the legacy financial system at large, providing greater access to those who may not otherwise have the opportunity to participate in the financial world.
Everyone from the unbanked to day traders and those braving the rough new world of decentralized finance may have a potential use case for stablecoins.
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