What are stablecoins?
If you observe the dynamics of even the most popular cryptocurrencies like Bitcoin or Ethereum, it quickly becomes obvious how volatile they are. The main goal of stablecoins is to provide a consistent value over time.
Table of Contents
- What are stablecoins?
- Why is there a need for stablecoins?
- Types of Stablecoins
- Fiat-backed coins
- Crypto-backed coins
- Non-collateral coins
What are stablecoins?
It is enough to look at the name of stablecoins to understand their nature. The idea behind the notion is to provide a digital asset that would combine the benefits of cryptocurrencies with inherent stability. If you observe the dynamics of even the most popular cryptocurrencies like Bitcoin or Ethereum, it quickly becomes obvious how volatile they are. The main goal of stablecoins is to provide a consistent value over time.
Why is there a need for stablecoins?
The reasons why people decide to become crypto adopters may vary: it might be the general curiosity, trading opportunities or desire to enter the world of decentralized finance with no regulations. It is possible that even more people would like to make use of the advantages they are offering yet remain hesitant due to a few flaws.
The first issue you come across in crypto is the price volatility – both intraday and over longer periods. With constant price swings, it is challenging and impractical to use cryptocurrency on a day-by-day basis, perform retail payments or use coins for long-term goals, like loans, payroll purposes or holding capital.
Largely resistant to volatility, stablecoins offer value stability along with the common benefits of crypto: affordability, fast and secure digital transactions and freedom from centralized authorities. These characteristics might tip the balance in favor of cryptocurrencies for those people who would like to join the world of crypto but remain hesitant. Stablecoins could also become the first step for the usage of cryptocurrencies on an everyday basis in some places like China or Nordic countries that are already advancing in moving away from cash. It is also certain that with the rising number of stablecoins in the past 2 years, new uses will be discovered and attract more adopters.
Stablecoins are also widely used at cryptocurrency exchanges. Normally, if an exchange wishes to introduce fiat currencies, it is associated with regulatory hurdles and additional procedures. However, if there are no fiat currencies available, it makes the platform less attractive for the new clients. Offering one or several stablecoins as a substitute for fiat is a convenient and simple solution both for the exchange and the customers. As a result, the funds may be easier and quicker transferred between exchanges without concerns for the price swings. In case of bear trends for “traditional” currencies, stablecoins allow to fix losses as well as diversify portfolio during the periods of instability for major currencies.
Some crypto exchanges are introducing their stablecoins and building partnerships with other services and exchanges to make it more convenient for their customers to move the funds. An example of such a coin would be Binance USD (BUSD), a currency created by Binance exchange in 2019 in partnership with Paxos Trust Company, a financial institution that also provides its stablecoin called Paxos (PAX). Founded by the Winklevoss brothers, Gemini exchange is also offering its stablecoin Gemini USD (GUSD), pegged to the value of the US dollar and based on Ethereum, same as TUSD. It is reported to be well-regulated and audited every month with the reports available for a wide audience online. Coinbase also provides its clients with its own crypto USD Coin (USDC) with the additional benefit of rewarding those who hold the coin on their exchange accounts.
Types of Stablecoins
There are two major types of stablecoins: collateralized and non-collateralized. The main difference is that collateralized coins are backed up by a certain asset, which can be fiat currency, cryptocurrency or other commodities, such as oil or gold (take Tether Gold (XAUT), for instance). The reason for having collateral is the need to minimize price fluctuation and provide proof for adopters that there is value behind the coin and their money can be liquidated at any moment. Non-collateralized coins do not have any asset behind to maintain the price, thus the stability is managed through the control of supply. Let us take a closer look at these types.
This is the most common type of stablecoins. Such coins are pegged to one of the real-world currencies, such as USD, EUR, or YUN, also known as fiat currencies. The usual collateralization ratio, in this case, is 1:1, meaning that for each digital coin there is one real coin stored in a bank. Due to the status of “traditional” currencies, coins backed by fiat offer solid stability and certainty. At the same time, it partly strips them of some inherent characteristics of cryptocurrencies. First of all, it makes them susceptible to changes happening in traditional financial markets and puts them at risk of inflation. Regular independent audits are required to prove that the funds stored in the bank are sufficient and correspond to the number of stablecoins in circulation, which is an expensive procedure and is not conducted frequently.
The most renowned fiat-backed stable coin is Tether (USDT). It was created way back in 2015 and has remained stable throughout its sometimes controversial history. At some point, it was blamed for not providing enough evidence that sufficient collateral is actually stored on any bank account, but the company managed to handle the critique and eventually share the proof of funds. Another widely spread stablecoin backed by USD is True USD (TUSD). It is based on Ethereum and makes part of ERC-20 coins, which adhere to a high standard developed for all tokens of the network. USD is popular collateral for cryptos, but, as mentioned above, not the only fiat that can be chosen as a peg. The first company that provides the liquidity of its coin with Euro is Stasis, a tokenization platform that created Stasis Euro (EURS).
Traditional cryptocurrencies, such as Bitcoin or Ethereum. may also serve as collateral for stablecoins. Stablecoins that are pegged to them can be considered more independent than the fiat-backed as they do not rely on centralized infrastructure. Besides, they are easier to audit since the capital is kept on the blockchain. On the other hand, due to the high volatility of traditional cryptocurrencies, it is more difficult to keep the 1-to-1 ratio as the hiccups of the market need to be smoothened. Such coins need to be overcollateralized so that the price truly can remain stable, something that requires a large investment.
An example of a crypto-backed stablecoin is DAI (DAI), a currency created by the MakerDAO platform. While the value of the token is intended to be kept at the $1 level, it is not collateralized by the actual USD, but by Ethereum stored on the platform at a 1.5 ratio.
Non-collateral coins are managed similarly to how fiat is managed by central banks.. This means that supply is based on demand: coins are destroyed as it rises and minted as it drops. As these stablecoins are not linked to any asset, they can be considered as the most independent and decentralized, governed solely by algorithms, and not affected by price fluctuations of another currency. At the same time, so far such coins have not been that successful in maintaining stable prices, leaving room for improvement.
As the field of digital finance is developing, cryptocurrencies are likely to become more widespread and their areas of use expanded. Due to the inherent characteristics of stablecoins, they are most likely to be adopted faster than other currencies. Thus, if your goal is to be on the cutting edge of modern technologies, feel safer about the value of your crypto assets, or be a part of the world of decentralized finance combined with stability, adding stablecoins to your portfolio will help you achieve it, while Guarda will assist in keeping your funds secure with its stablecoin wallets that can be quickly created.