What is Stablecoin?
The appearance of Bitcoin in 2009 allowed us to look at the financial market from a completely different perspective. What we had known as the only economic system has gained a serious digital competitor. Hundreds of new cryptocurrencies have been created since 2010. However, problems were soon discovered that prevented digital money from being widely adopted. One of them is price volatility. That is why the Stablecoin or pegged cryptocurrencies emerged.
Stablecoins aim to provide fixed prices. Given the great volatility of the market, cryptocurrencies do not allow maintaining the size of an investment portfolio or multiplying it in the long term. That is why the idea of stablecoins arises, to offer investors relative stability in the market. With stablecoins, it is easier to make profits or freeze them in a relatively stable cryptocurrency, with the possibility of waiting out periods of great fluctuations or being able to use them to make purchases in everyday life.
What are stablecoins?
Stable cryptocurrencies or Stablecoins are digital assets that aim to guarantee the stability of the price in the cryptocurrency market, generally by linking their value to fiat currencies such as the dollar or the euro. These coins are available on a blockchain that behave the same way as cryptocurrencies. They enjoy the many benefits of being a cryptocurrency (transparency, security, privacy) but without the extreme volatility that the other types of cryptocurrencies have.
Companies must deposit an equivalent amount of FIAT currency, such as US dollars, euros, or pound sterling, in bank accounts to issue these cryptocurrencies. By linking to real-world assets such as current currencies, stablecoins avoid the price volatility known in the cryptocurrency markets. Some of these stablecoins are pegged to other cryptocurrencies called algorithmic stablecoins. The linkage of these cryptocurrencies is maintained through stability and guarantee mechanisms.
How does stablecoin work?
All stablecoins are collateralized by another asset, but not all achieve this in the same way. Stablecoins can work in 3 ways:
- Fiat Collateralized Stablecoins
- Fiat-collateralized stablecoins are cryptocurrency backed 1:1 by an underlying government currency (such as USD or EUR) stored in a traditional financial institution.
- Algorithmic Stablecoins
Crypto collateralized stablecoins
Crypto-collateralized stablecoins are collateralized by one or more cryptocurrencies. They generally lack a central administrator, that is, they are decentralized. Instead, they rely on open software. It allows borrowers to lock up crypto assets to collateralize them and generate new stablecoins in the form of loans.
Algorithmic stablecoins are digital assets that rely on smart contracts to regulate their stability. Instead of using cryptocurrency deposits or issuing and redeeming debt, the software behind algorithmic stablecoins programmatically adjusts the supply of cryptocurrency as demand fluctuates.
Future of stablecoins in cryptocurrency market
Stablecoins have been developed as a product halfway between decentralized cryptocurrencies, such as Bitcoin, and centrally managed fiat money, such as the US dollar. These hybrid instruments have grown rapidly. However, stablecoins are not the same as traditional cryptocurrencies. Its operation leads to a paradoxical situation: The Bitcoin blockchain, the chain that created the entire movement, was initially developed to bypass financial institutions.
It is now these same financial institutions and centralized organizations that play an increasingly important role in the world of cryptocurrencies. Stablecoins represent dialogue, dependency, and compromise between financial institutions and governments that, in many cases, indirectly provide an inevitable and logical evolution to this asset class. These cryptocurrencies continue to grow and are increasingly accepted, both by users and financial institutions, and governments worldwide.
What are the most used stablecoins?
Tether (USDT) is the most popular stablecoin on the market and boasts the largest trading volume and market capitalization of any other stablecoin. Another of the most used stablecoins is the USD Coin (USDC), which is becoming quite popular and is becoming more so as the cryptocurrency market matures. It is also backed by USD and is based on the popular Ethereum (ERC-20) protocol.
One stablecoin that has gained popularity is the Paxos Standard Token (PAX) USD-backed stablecoin fully managed by Paxos Trust Company and regulated by the New York State Department of Financial Services (NYDFS). Like most other stablecoins, it is based on the ERC-20 protocol. Binance USD (BUSD) is a stablecoin that has undoubtedly earned its place among the most widely used stablecoins, US dollars fully back it, and it guarantees faster ways to finance your transactions.
Advantages of stablecoins
Stablecoins have several advantages. First, the low volatility helps offset movements in other virtual currencies. Next, the digital and decentralized nature of Blockchain allows stablecoins to benefit from high mobility and ease of exchange. For example, transferring stablecoins is faster and generally more transparent than the traditional banking system. On the other hand, stablecoins allow you to keep your profits. Gains can be secured through conversion into stablecoins.
In the retail payments market, stablecoin-based solutions seek to meet evolving consumer preferences in favor of instant, continuous and standardized payments as consumers become increasingly mobile. The current electronic means of payment offer does not have a universal and ergonomic cross-border solution similar to person-to-person cash payments. Stablecoins could be seen as a universal means of payment facilitating cross-border payments in a single unit of account.
Disadvantages of stablecoins
Stablecoins are less liquid than regular cryptocurrencies, especially those coins that are pegged or collateralized by commodities like gold. On the other hand, stablecoins pegged to traditional fiat currencies (FIAT) are vulnerable to a crash. If a stablecoin is backed by a collapsing coin, the stablecoin will lose its value. Even if a currency is pegged to another cryptocurrency, it can also depreciate along with the base currency's exchange rate.
Furthermore, crypto-backed stablecoins are the most difficult and risky asset. Another point against stablecoins is that they do not have fully decentralized control to secure their financial services, like bitcoin or Ethereum, since local laws can restrict their circulation. For example, if a country has a high inflation risk, the authorities can block stablecoins linked to foreign currencies to protect the national currency.