Cryptocurrencies are highly secure and allow for speedy transactions, but their volatile prices can induce headaches. Stablecoins aim to do away with that and give people peace of mind. Here’s how.
Keeping up with the prices of cryptocurrency is a veritable rollercoaster ride, no matter which one you’re talking about.
Bitcoin for one, has seen everything. From steep price drops as a result of China’s crackdown on cryptocurrency to sharp price hikes after a Bitcoin-linked ETF was approved, its investors must surely be hodl-ing on to dear life by now.
Stablecoins, on the other hand, are the complete opposite. This breed of cryptocurrencies was created for the sake of price stability while offering the same transaction speed and security that cryptocurrency enthusiasts are accustomed to.
Having a stable price also encourages more widespread adoption and usage rather than just speculative trading.
Although every stablecoin serves the same purpose, there are quite a few being circulated right now. And that’s to be expected, given the variety of fiat monies and commodities that exist globally too.
Here’s all you need to know about stablecoins and how they form the backbone of the cryptocurrency industry.
- What types of stablecoins are there?
- Which stablecoins are popular among cryptocurrency users?
- Are there any risks to using stablecoins?
What types of stablecoins are there?
As mentioned above, there are a number of stablecoins that businesses and individuals around the world utilise. They can be pegged against a currency, commodity, or even against other cryptocurrencies.
For instance, the U.S Dollar alone has several stablecoins tied to it, such as Tether and USD Coin.
Here are the four types of stablecoins that are currently available for cryptocurrency users:
1. Fiat-backed stablecoins
Stablecoins pegged against an existing fiat money are the easiest to grasp and were the first to arrive on the scene in 2014. Think of these as digital versions of a currency, whether it’s Tether for the U.S Dollar or VNDT for the Vietnamese Dong.
The issuers of these stablecoins must have financial reserves that are equivalent to the number of tokens that they distribute. Otherwise, these tokens would be rendered worthless, akin to banana money decades ago.
Fiat-backed stablecoins facilitate trades on cryptocurrency exchanges and can be exchanged back to their fiat versions at a 1:1 ratio anytime. Although there are still regulatory concerns regarding these stablecoins, they should be quelled as the industry continues to mature.
2. Commodity-backed stablecoins
Now that you know what fiat-backed stablecoins are and how they function, you can probably guess what commodity-backed stablecoins are.
An example would be Palladium Coin, which you can redeem for the eponymous precious metal. There’s the Digix Gold token too, which is pegged against actual gold.
Stablecoins that are pegged against commodities help users hedge against inflation without having to bear the cost of storing the physical assets. This is akin to commodity ETFs, except that you can redeem the actual commodity should you wish to do so.
Do note that the issuers of these stablecoins need to have reserves that are equal to the number of tokens that they distribute as well.
3. Cryptocurrency-backed stablecoins
Despite having different names, cryptocurrency-backed stablecoins and their fiat-backed counterparts function similarly.
For example, DAI is a cryptocurrency-backed (Ether, to be precise) stablecoin that tracks the U.S Dollar’s price. Therefore, DAI is able to facilitate trades on cryptocurrency exchanges too.
In this case, the difference would be in the stablecoin’s reserves. Fiat-backed stablecoins need to have their reserves in the form of fiat money whereas cryptocurrency-backed stablecoins utilise cryptocurrency.
As cryptocurrency prices are still highly volatile, cryptocurrency-backed stablecoins will have a higher level of reserves than the number of tokens issued. This is known as over-collateralisation.
Although cryptocurrency-backed stablecoins are harder to create and maintain, regulation is much easier as they aren’t controlled by a single entity and are fully based on the blockchain.
4. Algorithmic stablecoins
For cryptocurrency enthusiasts, algorithmic stablecoins are akin to the holy grail. Like cryptocurrency- and fiat-backed stablecoins, the prices of algorithmic stablecoins are pegged against a chosen fiat money.
However, algorithmic stablecoins maintain their value by controlling the supply of tokens using software and a set of rules. No collateral of any sort is needed on the issuer’s end, which is akin to how a central bank operates.
Unfortunately, successful algorithmic stablecoins are currently as elusive as the holy grail itself. Even TerraUSD took around a year before it started trading consistently at US$1, with a +/- US$0.1 deviation. It’ll take a while before other alternatives emerge.
Which stablecoins are popular among cryptocurrency users?
|Stablecoin||Type||Market Capitalisation (October 2021)|
|Tether (USDT)||Fiat-backed stablecoin (US$)||S$92.8 billion|
|USD Coin (USDC)||Fiat-backed stablecoin (US$)||S$43.6 billion|
|Binance USD (BUSD)||Fiat-backed stablecoin (US$)||S$17.8 billion|
|Dai (DAI)||Ethereum-backed stablecoin (US$)||S$8.7 billion|
|TerraUSD (UST)||Algorithmic stablecoin (US$)||S$3.7 billion|
It’s no surprise that the top five stablecoins by market capitalisation right now are all alternatives to the U.S Dollar, no matter their underlying mechanics. After all, the U.S Dollar is the world’s reserve currency and that isn’t set to change anytime soon.
Having USD-pegged stablecoins on hand means that you can execute trades instantly at a low cost. Furthermore, there are cryptocurrency exchanges that do not accept deposits in fiat money, so these stablecoins are absolutely essential if you want a piece of the Bitcoin pie.
Leading the pack of USD-pegged stablecoins by a mile is Tether and its market capitalisation of US$92.8 billion.
What’s more, the world’s top cryptocurrency exchanges use Tether for trades, including Huobi Global, Kraken, and KuCoin. Many have even said that it has reached a stage where it’s too large to fail.
Are there any risks to using stablecoins?
Stablecoins are well-known for their high liquidity, a quality that does lower the risks involved. If you’d like to swap your stablecoins for fiat money, you can easily do so via a peer-to-peer trade on a cryptocurrency exchange.
This is much quicker than withdrawing your money from a traditional stock brokerage or trading platform, taking just minutes compared to the several business days that you’ll need to wait.
Unfortunately, low risk doesn’t mean no risk. As mentioned above, there are regulatory concerns surrounding stablecoins and cryptocurrency in general.
Tether for one, is no stranger to controversies, with the organisation behind it being reluctant to reveal the full extent of its reserves till today.
However, other stablecoin issuers have taken this greater scrutiny on the chin, working with the authorities to ensure a squeaky clean record. USD Coin for one, has been given the green light by regulators across the USA and its issuer is a registered money services business to boot.
This provides cryptocurrency enthusiasts with greater assurance and helps ensure that the token receives wider acceptance.
Conversely, stablecoins are highly risky as an investment. Because they’re essentially the digital equivalents of money, they’re subject to the effects of inflation too. It’s no different from putting cash in a piggy bank.
One will need to put these stablecoins to work in order to generate a return on the investment, whether it’s cryptocurrency trading, staking, or other alternative methods.
Stablecoins are the backbone of the cryptocurrency industry, facilitating transactions across the board and often acting as the first touchpoint for budding investors.
Additionally, stablecoins boast the same level of speed and security as other cryptocurrencies when it comes to making transactions. This is in stark contrast to fiat money, where instant and low-cost transfers across borders are still a work in progress.
Stablecoins grant an additional avenue for underbanked communities to transact easily and securely. This is why people in emerging markets like India and Pakistan have embraced cryptocurrency wholeheartedly.
Many cryptocurrencies out there are liable to give investors a rude shock, especially when a piece of bad news breaks. Bitcoin and Ether are still not immune to this, let alone newer kids on the block like Solana or Polkadot.
Fortunately, price stability is the name of stablecoin’s game, giving users peace of mind whenever they need to make a transaction. Whether it’s securely cashing your profits out or paying a merchant for his goods and services, stablecoins are designed for consistency.
If only a certain Laszlo Hanyecz had his insatiable craving for Papa John’s pizza several years later.
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