Crypto

Understanding the Concept of ‘Stablecoins’

Stablecoins

Introduction

The cryptocurrency market is one of the most volatile markets in the world. There has been a serious number of scenarios where prices of tokens have surged by more than 100%, 1000%, and even more. In the crypto market, profit or loss can happen very quickly. Especially in the most unpredictable manner.

In a market where prices can surge anytime, there is a need for some sort of mechanism or provision to ensure stability. This is where the stablecoins come in. Drawing logical inspiration from the words “stable” and “coin”, stablecoins are coins that their values do not fluctuate like the other variations of cryptocurrencies. The most common examples of these coins are Tether (USDT), USD coin (USDC), Binance USD (BUSD), Digix Gold Token (DGX), Havven. etc.

How Stablecoin Works

Most types of stablecoins are usually pegged to either a fiat currency (e.g., US Dollar), or a certain commodity (e.g., gold), or another cryptocurrency itself.  Although, the Seigniorage stable coins are not pegged to any entity. They use a special algorithm to create and destroy tokens. They are less popular and the least adopted. These variations will be discussed in detail in this article.

Since their values are pegged to another entity, their values themselves would never change unless the value of the entity to which they are pegged changes. For instance, a stablecoin pegged on the United States Dollar (USD) would be worth the same. A $100 is the same as 100USDT.

On most trading platforms, most cryptocurrencies are pegged against stable coins. This has made it possible for people to buy and sell other forms of cryptos within the cryptocurrency space without having to deal directly with fiat.

The first stablecoin is the Tether (USDT) and it is pegged on the United States Dollar. It was created in 2014. The idea is that for every dollar deposited, one would receive the token. This token can be exchanged back to dollars anytime.

Types of Stablecoins

The two categories of stable are the backed stable coins and the non-backed stable coins.

Backed Stablecoins

Stablecoins can be pegged on fiat, a certain commodity, or a certain cryptocurrency itself.

Fiat-backed Stablecoins

These are stablecoins pegged on fiat currencies. The value will always reflect the currency it has been pegged on. Tether is the most popular stablecoin that exists. It is pegged against the United States dollar. 1 (Tether) USDT is the same as 1 dollar.

Fiat-backed stablecoins are created to reconcile the huge difference between cryptocurrencies and fiat currencies.  Examples of fiat-backed stablecoins include- USDT, USDC, BUSD, TUSD, Diem, etc.

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Commodity-backed Stablecoins

This is when a certain commodity is being used as a yardstick for the value of such stablecoin. An example of such a commodity is Gold, which serves as a peg for Digix Gold Tokens (DGX). Silver Coin, Silverlinks (LKNS), and Silver Token are examples of tokens backed by “Silver”. A lot of precious commodities have their cryptocurrency coins.

Cryptocurrency-backed Stablecoins

Simply, this is when cryptos are used to back other cryptos. It is similar to fiat-backed stablecoins. The difference is that smart contracts on the blockchain network are used in a more open way to carry out its network operations. The fiat-backed stablecoin’s collateralization is usually done offline.

Merits of Stablecoins

  • They ensure price stability
  • They have also served as the primary or default currency for purchasing other types of cryptocurrencies on popular exchanges.
  • Suitable for everyday use. People can spend their USDT like they would spend their Dollars
  • Easy for international payments. Most international money transfer platforms charge outrageous fees for sending and receiving payments. Sending stablecoins will ensure that the value of the funds is still intact for a lesser fee.
  • They can be used for lending, staking, borrowing, and other forms of investment that one can originally carry out with fiat currencies.
  • It provides the highest form of privacy ever. One can carry out financial transactions at top-level privacy compared to the centralized system of carrying out transactions traditionally.
  • It is the easiest method of taking profits or stopping losses during trading.
  • Stablecoins make it so easy to hold and switch to other cryptos within a wallet.
  • It is less susceptible to hacks.

Demerits of Stablecoins

Some of the shortcomings of stablecoins include;

  • Transparency: Tether, for instance, is an example. There have been cases where professionals have called them out for failing to provide audits of their reports.
  • Apart from the anonymity feature that would naturally come with blockchain, it is often argued that the fiat-backed stablecoin can offer more than what conventional banks would.
  • Since they are attached to centralized entities, somehow, they can feel the impacts of regulation.

Conclusion

The future of the crypto space is filled with unimaginable potentials and opportunities. While there are so many pros and cons associated with crypto It is safe to say that the use to which stablecoins can be put into in the nearest future is unknown. As the world’s acceptance of cryptocurrency grows, it would be nice to see where the future of stablecoins is headed and how improvements will be made.

The Author

Awoyele Olanrewaju

Lanre is a professional writer with over eight (8) years of experience. He has created various content across multiple niches such as business, academic, grant research, and cryptocurrency.

His research and writing skills have helped start-ups and non-profit organizations secure grants. He has also worked with different De-Fi organizations such as Algorand, Bluezelle, and EasyFi, and Status to create amazing cryptocurrency content.