“Stablecoin,” experts believe, is a revolution to current financial limitations. This digital money has the power to overturn powerful economies, overcome debt collapse, and even preserve the value of their earnings.
But what exactly is this mysterious digital currency? Why is it causing such a stir in the finance industry?
Well, if you are familiar with Bitcoin, you would know the cryptocurrency is known for its wild price swings and high volatility. Stablecoin, on the other hand, is a type of cryptocurrency that maintains its price forever.
In this article, we will dive into stablecoin, exploring its background, how it works, its types, features, and whether it is a good investment or not.
What is a stablecoin?
A stablecoin is a digital currency that can maintain a stable value when pegged against a fiat currency, reserves, or other commodities. Unlike cryptocurrencies like Bitcoin or Ethereum, known for their volatility, stablecoins are designed to minimize price fluctuations and maintain stability in the market.
The main objective of stablecoins is to ensure fast and low-cost transactions with low volatility risk. Furthermore, they close the gap between the traditional financial systems and cryptocurrencies.
Due to their stability, we can use stablecoins in online purchases, savings, and remittances. In short, stablecoins offer users and businesses a more stable as well as familiar medium for exchange.
Since these are pegged against fiat, they are an important tool for the adoption of decentralized applications and decentralized finance (DeFi) platforms.
What’s the difference between stablecoins and flatcoins?
We use the terms stablecoins and flatcoins interchangeably, but both of them refer to slightly different concepts:
Stablecoins
Stablecoins are a type of cryptocurrency with a stable value, pegged by specific or a combination of assets. These assets can include fiat currencies, other cryptocurrencies, or commodities. The primary goal of stablecoins is to mitigate the price volatility characteristic of traditional cryptocurrencies like Bitcoin.
Flatcoins
The term “flatcoin” is less commonly used. It may refer to a specific type of stablecoin that is only pegged to a fiat currency. A “flat” means a national or government-issued currency, for example, the US dollar, euro, or yen. Flatcoins would aim to maintain a one-to-one peg with the value of the linked fiat currency.
While stablecoins encompass a broader category of cryptocurrencies designed for stability, flatcoins could be considered a subset of stablecoins that focus solely on mirroring the value of a specific fiat currency. The choice of words may vary sometimes, which can be confusing.
Why have stablecoins become so important?
Stablecoins have become important in the world of crypto due to the following key reasons:
Lowers the risk of price volatility
Due to low price volatility, traders primarily use stablecoins for non-fiat crypto exchanges. During the early days, the lack of USD or other fiat currency in the first crypto exchanges, there was a need for stablecoin as a fiat equivalent. Traders could move into the stablecoin to protect their gains.
Fiat currency to cryptocurrency exchange medium
To step into the space of cryptocurrency, the first step is to convert the fiat currency into cryptocurrency. After converting fiat to USDT, USDT can be used to buy cryptocurrency, tokens, and other stuff built on blockchain, which can’t be bought with fiat.
When digital asset exchanges did not include fiat-crypto trading pairs, convertibility became more of a problem. Convertibility is less of a barrier now that digital asset exchanges like Coinbase offer smooth fiat on- and off-ramps for major traditional currencies.
Popular way to move assets on the blockchain
Stablecoins are the safest and most preferred way of transferring assets within the blockchain ecosystem. Their stability, typically pegged to well-established assets like fiat currencies, makes them a reliable medium for moving assets across blockchain networks.
You can use them to move value on a blockchain, although numerous cryptocurrencies have a variety of purposes.
The key building block of DeFi
In DeFi, stablecoins are like reliable and steady workhorses, maintaining a constant value while enabling users to earn interest, borrow assets, trade with stability, and more. Many platforms also recognize their collateral value for loans, fuel liquidity in exchanges, and streamline cross-border transactions, making DeFi accessible and efficient by minimizing the rollercoaster-like price swings often associated with cryptocurrencies.
DeFi is dependent on stablecoins in several ways. Curve, one of the more significant DeFi protocols with more than $20 billion in total locked value, primarily acts as a market for traders to swap various stablecoin kinds with minimal costs and slippage.
Convex and Yearn are two DeFi protocols that have developed their platforms expressly to assist investors in trading on Curve. These protocols facilitate investors to make multi-billion dollar investment funds in Curve’s stablecoin pools.
Similarly, DeFi lending protocols exist that let lenders give loans to borrowers in the form of stablecoins, such as Aave and Compound. The lending platforms would not be able to operate if these loans were denominated in a volatile asset like Bitcoin.
- If the value of bitcoin increased, the collateral provided by the borrowers would not be enough to cover the loan’s value.
- If the value of Bitcoin decreased, the borrowers would have less money overall.
According to cryptocurrency monitoring and analytics website CoinGecko, DeFi has increased its worth to around $150 billion, partly thanks to stablecoin technology.
Background Facts
The cryptocurrency market is still in its early stages, and digital assets have little liquidity. Low liquidity thus leads to high volatility. Because of the frequent price swings, high volatility continues to be an issue for the widespread adoption of crypto assets.
These issues led to the creation of stablecoins. Stablecoins leverage blockchain technology to produce stable cryptos relative to the pegged external asset class.
- Who created the first stablecoins?
BitUSD, introduced in 2014, was the first stablecoin to be released as a token on the BitShare blockchain. Charles Hoskinson and Dan Larimer, two well-known names in the blockchain sector, created the first stablecoin. The token was collateralized by various other cryptocurrencies, all of which were locked in smart contracts and served as security for the token. The BitShares BTS core token backed it.
With the introduction of BitUSD and NuBits in 2014, stablecoins were first introduced. But BitUSD lost its 1:1 peg to the US dollar in the latter part of 2018, raising questions about its stability. It now trades at roughly 80 cents to the dollar.
When NuBits was first released in September 2014, its governance model was the controversial Seigniorage system. Although it initially rose beyond $1.20, it was extremely volatile, with falls in 2016 and 2018.
This highlights how stablecoin demand typically increases during bear markets, pushing their values lower during bull markets. Additionally, it emphasizes how crucial it is to preserve the peg for tokens promoted as stablecoins because deviations may result in legal action.
The stablecoin Tether (USDT), formerly known as RealCoin, hit the market in 2015 and quickly gained popularity on Bitfinex. Tether has, nevertheless, been the subject of investigation and debate, including a $31 million hack in 2017 and claims of price manipulation connected to Bitfinex trade, which has attracted regulatory interest. Despite these difficulties, Tether remains a major player in the stablecoin market.
How do stablecoins work?
Stablecoins try to peg their market value to an outside standard, typically a fiat currency. They function better as a means of exchange than more volatile cryptocurrencies. To control supply, stablecoins may use an algorithm or be pegged to a currency like the US dollar or the price of a commodity like gold. Additionally, they keep reserve assets on hand using algorithmic supply-controlling methods or as collateral.
Types of stablecoins
Stablecoins come in various types, each with a unique stability-maintaining mechanism. Let’s get into these categories in more depth:
1. Fiat-collateralized stablecoins
Reserve assets back fiat-collateralized stablecoins, frequently common fiat currencies like the US dollar (USD), euro (EUR), or yen (JPY).
Stability is ensured by holding a bank account of a comparable amount of the reserve currency for each stablecoin created. A few examples include TrueUSD (TUSD), USD Coin (USDC), and Tether (USDT).
2. Cryptocurrency-backed stablecoins
Stablecoins backed by cryptocurrencies use other cryptocurrencies as security to keep their value. To create stablecoins, users place a certain quantity of cryptocurrency assets into a smart contract.
The contract manages the collateral, which also issues or burns stablecoins as necessary to maintain their value. MakerDAO’s DAI is a noticeable example of this type.
3. Precious Metals stablecoins
Certain stablecoins are linked to the price of precious metals like gold. To provide stability and give exposure to the value of the underlying asset, each token represents a precise amount of the metal. Tether Gold (XAUT) and PAX Gold (PAXG) are examples.
4. Algorthimatic stablecoins
Algorithmic stablecoins use intelligent contracts and algorithms to regulate the number of available tokens. The algorithm modifies the token supply to restore stability when the stablecoin’s price deviates from its desired value. Ampleforth (AMPL) is an example of an algorithmic stablecoin.
Others
There are numerous experimental stablecoin models in addition to the abovementioned categories. These may include hybrid stablecoins, those controlled by decentralized autonomous organizations (DAOs), and those backed by tangible assets like real estate.
What can you do with stablecoins?
Stablecoins are incredibly versatile within the cryptocurrency ecosystem. They serve as a reliable digital currency for everyday transactions, provide an efficient means for cross-border remittances, offer a stable store of value amid market volatility, and play a pivotal role as collateral in decentralized finance (DeFi) applications.
It also enables users to access various financial services within blockchain networks. Whether making payments, sending money globally, or participating in DeFi activities, stablecoins are a fundamental tool for various crypto-related activities.
Use case of stablecoins
Stablecoins offer a variety of practical uses:
- Digital Payments: Use stablecoins for daily transactions, just like you would with traditional currency.
- Cross-Border Money Transfers: Facilitate quicker and more cost-effective international money transfers than traditional remittance services.
- Investment: Certain users regard stablecoins as a secure refuge during cryptocurrency market turbulence.
- DeFi Collateral: Within the decentralized finance (DeFi) domain, you can use stablecoins as collateral for lending, borrowing, providing liquidity, and participating in yield farming.
Top 5 Stablecoins by Market Cap
According to the most recent data, these are the top five stablecoins by market capitalization:
- Tether (USDT): Tether is among the first and most popular stablecoins. It has the most significant market cap among stablecoins and maintains a 1:1 peg to the US dollar.
- USD Coin (USDC) is a well-known fiat-collateralized stablecoin known for its transparency and frequent audits launched by Circle.
- Binance USD (BUSD): Since its launch by the cryptocurrency exchange Binance, BUSD has become more well-known within the Binance community.
- DAI: DAI shines out as a decentralized stablecoin controlled by the MakerDAO community. Through crypto collateral, it ensures stability.
- TrueUSD (TUSD): TrueUSD is renowned for its regulatory observance and transparent reserves.
What is the best stablecoin?
Tether is the best stablecoin in the market. It is market capitalization’s most widely used and valuable stablecoin. It has a 1:1 exchange rate peg to the US dollar and is backed by gold reserves.
It frequently ranks among the top five cryptocurrencies in terms of market cap. You may find Tether on the most prominent crypto exchanges, such as Kraken, Binance, and Coinbase.
How many stablecoins are there?
Stablecoin availability is continually changing as new initiatives and projects are launched. There are currently up to 200 stablecoins available on the market, some of which have already been released, and some are still under development.
What are the advantages of stablecoins?
To understand why stablecoins are becoming increasingly popular in banking and digital transactions, let’s go deeper into their advantages.
Little to no volatility
Stability is one of the main benefits of stablecoins. Unlike other cryptocurrencies, stablecoins are intended to have a stable value. They are frequently anchored to a reserve asset like fiat money (USD or EUR) or a commodity (gold). Because of this pegging, stablecoins are protected from the sharp price swings experienced by Ethereum and other cryptocurrencies.
Users and businesses can transact and hold value without worrying about losing a sizable amount of their assets overnight. This stability offers them a sense of security.
Global payment and remittance
Stablecoins make international transactions straightforward and borderless possible. Because of intermediaries and different currencies, conventional international money transfers can be expensive and time-consuming.
By enabling users to transfer and receive money internationally with low costs and quick processing times, stablecoins remove these obstacles. Compared to traditional banking systems, this functionality benefits cross-border remittances, allowing people to send money to their families in other countries quickly and affordably.
Fast transactions
Blockchain technology, which stablecoins use, enables quick and safe transactions. Stablecoin transactions settle in only minutes, unlike traditional banking systems, which may take several days to process international transfers, making them perfect for time-sensitive payments and transactions.
This speed is beneficial in e-commerce, where prompt payment processing matters for a pleasant consumer experience.
Protecting cryptocurrency traders
Stablecoins protect against market volatility for cryptocurrency traders and investors. Traders can immediately transfer their assets into stablecoins to preserve the value of their investments during periods of extreme volatility in the cryptocurrency market.
The ability to transform volatile assets into a stable form safeguards traders from losses during market slumps. Stablecoins also offer the crypto ecosystem liquidity, enabling traders to quickly enter or exit positions without relying on fiat currencies and conventional banking systems.
What are the drawbacks of stablecoins?
Stablecoins have several advantages but have certain drawbacks:
Centralization Risk
The reserve assets that back many fiat-collateralized stablecoins are managed by centralized organizations, such as banks or financial institutions. This adds a degree of centralization and counterparty risk.
The stability and dependability of the stablecoin may be impacted if the custodian or issuer experiences financial or regulatory problems.
Regulatory Concerns
Stablecoins often face regulatory scrutiny, especially those linked to fiat currencies. Governments and financial institutions may impose regulations that affect stablecoin issuers’ activities and use.
For instance, regulatory modifications might mandate audits, Know Your Customer (KYC) and Anti-Money Laundering (AML) compliance, or even restrict an issuer’s activities.
Dependence on Reserve Assets
Stablecoins backed by fiat collateral are only as stable as the currencies they are collateralized with. The stability of the stablecoin may be jeopardized by a severe devaluation or inflation of the underlying fiat currency.
If users doubt the issuer’s capacity to keep the peg, they may stop trusting the stablecoin.
Limited Transparency
Some stablecoin projects need more transparency in their business practices, particularly regarding the assets used as backing. Users may have trust concerns as a result of this lack of transparency.
Are stablecoins similar to cash?
Stablecoins are similar to cash in some ways, as they both serve as reliable means of exchange and stores of value. However, stablecoins are digital assets that operate on blockchain networks, while cash is physical currency.
The main difference is that stablecoins offer the stability of a fixed value or peg, often tied to a fiat currency like the US Dollar. In contrast, cash can be subject to inflation and changes in value over time.
So, while stablecoins share some similarities with cash regarding utility, they are distinct in their digital, blockchain-based nature and consistent value.
Do Stablecoins Pass the Howey Test?
The Howey Test is a legal framework established by the United States Supreme Court to determine whether a transaction qualifies as an “investment contract” and falls within the security definition.
Stablecoins, on the other hand, are a digital asset often pegged to a Fiat currency like the US dollar, aiming to provide stability in value and serve as a medium of exchange.
Whether stablecoins pass the Howey Test depends on the specific characteristics and features of each stablecoin. The test looks at various factors such as an investment of money, expectation of profits, joint enterprise, and dependence on the efforts of others.
If a stablecoin meets these criteria, it could be classified as a security and subject to securities regulations.
It’s important to note that stablecoin projects and issuers actively work with legal experts and regulatory bodies to ensure compliance with applicable securities laws and regulations. The evolving nature of the regulatory landscape requires ongoing evaluation and adaptation to ensure compliance with existing laws and frameworks.
Is Bitcoin also a stablecoin?
No, Bitcoin is not a stablecoin. Due to its significant price fluctuations, Bitcoin is categorized as a decentralized cryptocurrency. Its value can undergo substantial changes over short periods, making it more akin to a speculative instrument than a dependable store of value.
Is Ethereum a stablecoin?
Ethereum also falls outside the category of stablecoins. Ethereum represents blockchain technology that facilitates the creation of multiple cryptocurrencies and decentralized applications (DApps).
While Ether (ETH), Ethereum’s native token, is utilized for covering transaction fees and executing smart contracts within the Ethereum network, its value is determined by market volatility and does not possess a fixed price.
Is PayPal a stablecoin?
Even though PayPal recently launched its stablecoin, it’s crucial to remember that it is primarily a digital payments platform and isn’t solely focused on stablecoin services. PYUSD, PayPal’s stablecoin, is linked to the U.S. dollar and offers stability for customers who want to deal in a digital currency with the knowledge that there is a 1:1 ratio to the dollar.
Is it good to invest in stablecoin?
Investing in stablecoins deviates significantly from conventional asset investments like stocks or real estate. Stablecoins are primarily engineered for stability and as a medium for conducting transactions rather than generating investment profits.
Holding stablecoins can be a secure method to temporarily park your funds, mainly when you aim to shield them from the volatility often associated with other cryptocurrencies.
Nevertheless, stablecoins are not conducive to substantial capital appreciation. If your objective is long-term investment growth, alternative assets may prove more suitable.
Can I create a stablecoin?
Yes, you may design your stablecoin, but doing so requires careful preparation, a lot of money, and strict respect for legal requirements.
A stablecoin must be created in various steps, including choosing its specific type (fiat-collateralized, crypto-backed, or algorithmic) and setting up procedures to maintain its stability. Along the way, it is essential to consider aspects like legal compliance, thorough auditing, and strong security measures.
How do stablecoins remain stable?
Stablecoins maintain stability through collateralization, algorithmic adjustments, or asset backing. For example, fiat-collateralized stablecoins hold fiat currency reserves equivalent to the value of all issued tokens, ensuring a 1:1 peg. Algorithmic stablecoins adjust their supply based on market demand to stabilize prices.
What is the future of stablecoins?
In the coming years, stablecoins will become more prevalent and significant in cryptocurrency. Stablecoins offer a more dependable alternative to regular cryptocurrencies, which are more volatile and make them unsuitable for daily use or investment.
With significant payment processors like PayPal and Visa now accepting some stablecoins as payment, stablecoins are also becoming more accessible. Stablecoins also make cross-border transactions more effective.
Traditional banking systems have expensive transactions that sometimes take days to clear. Stablecoins are convenient for businesses and consumers because transactions can be done quickly and cheaply.
In five years, the stablecoin market is projected to increase from $125 billion to $2.8 trillion, according to a research report by broker Bernstein.
Conclusion
Stablecoins have emerged as an essential element within the cryptocurrency market. Their capacity to facilitate rapid and cost-effective transactions, function as collateral in the DeFi sector, and enable efficient cross-border remittances positions them for ongoing growth.
However, challenges like regulatory scrutiny and the risks associated with centralization must be addressed to ensure their sustained success.
As the cryptocurrency landscape evolves, stablecoins will likely persist as a foundational element, bridging the divide between traditional and digital finance. With their unique features and growing adoption, stablecoins are worth keeping an eye on as they continue to play a pivotal role in shaping the future of financial transactions.
