What are stablecoins?

Amidst the whirlwind of the crypto realm, stability has been a rare gem to find. This scarcity gave birth to stablecoins, envisioned as a beacon of assurance in the changeable landscape of digital assets. In contrast to their unpredictable counterparts, these constant-value tokens were crafted to offer investors a sanctuary of steadiness. Even so, the actual performance of these coins has at times fallen short of their pledged stability. Over the last few years, some of the most notable stablecoins by market cap have experienced recurrent dips below the value of their pegged assets, a phenomenon recognized as “depegging.” 

Big players like PayPal and Visa entering the scene highlight the growing interest in stablecoins, showing that more people are getting into this type of cryptocurrency. As more folks consider getting steadier digital currency, the questions persist: what are stablecoins in crypto? What are the stablecoins’ types, advantages and risks? This article seeks to demystify the concept, shedding light on the role and mission of fixed-value coins in the crypto landscape.

Understanding Stablecoins

Stablecoins stand out as a distinct crypto class, carefully crafted to offer a stable source of value in the dynamic and often changeable digital asset space. In contrast to central bank digital currencies (CBDCs), which essentially digitize government-backed fiat currencies, stablecoins are overseen by private entities. They work on their own, cutting out middlemen, which makes transactions smoother and less costly for global payments. This makes them exceptionally valuable for facilitating seamless cross-border money transfers. 

What distinguishes stablecoins is their stability (compared to other cryptocurrencies). These coins are commonly supported by a reserve of assets, frequently in a one-to-one correlation with a stable asset such as the US dollar. By doing this, stablecoins make sure their value closely follows the chosen asset, offering a shield against market ups and downs. This feature has made weakly fluctuating crypto popular among investors looking for a reliable digital alternative to traditional currencies.

Types of stablecoins

Stablecoins come in various types. The categorization is based on how they secure their stability. And whether they are controlled centrally or in a decentralized manner.

• Collateral-Backed Stablecoins:

• Fiat-Reserve Anchored: 

These stablecoins draw strength from conventional fiat currencies like the US dollar, euro, or yen. Stability is upheld by reserving an equal amount of the fiat currency for each unit of the stable coin in circulation. Notable instances encompass Tether (USDT) and USD Coin (USDC).

• Commodity-Backed: 

Certain stablecoins derive their stability from tangible commodities such as gold or other precious metals. The stable coin’s value is tethered to the worth of the underlying commodity, forging a link between digital and physical assets.

• Cryptocurrency-Collateralized: 

These stablecoins deploy alternative cryptocurrencies as collateral. For instance, it may be buttressed by a reserve of Ether (ETH) or Bitcoin (BTC). Smart contracts and decentralized finance (DeFi) platforms frequently manage the collateralization process.

• Algorithmic Stablecoins:

This category dispenses with traditional collateral and instead employs algorithmic protocols to regulate the circulating coin supply. By dynamically modifying the coin supply in response to market dynamics, algorithmic stablecoins endeavor to preserve a steady value. Examples include Ampleforth (AMPL) and Terra (LUNA).

• Centralized vs. Decentralized Stablecoins:

• Centralized Stablecoins: 

These are dispensed and overseen by a centralized entity or establishment, often a private enterprise or a financial institution. They rest on trust in the issuing entity and are subject to regulatory scrutiny. Illustrations encompass USDT and USDC.

• Decentralized Stablecoins: 

These are governed by smart contracts and decentralized protocols on platforms like Ethereum. They aim for stability using algorithms and collateralizing with other cryptocurrencies. The ambition of decentralized stablecoins is to function without the need for a central authority. Instances include DAI and sUSD.

These stablecoin types offer a range of options for investors and users based on their needs and risk preferences.

What are the Most Popular Stablecoins?

Like regular cryptocurrencies, stablecoins can be analyzed by assessing indicators such as market capitalization, trading volume and circulating supply. The first pair of metrics is particularly crucial when gauging the demand and significance of coins.

If we evaluate the popularity by market capitalization, then the top three coins are: 

Tether USDt (USDT) with a market cap of $83,845,805,310, USDC (USDC) with a cap of $25,378,383,620, and Dai (DAI) with a total market value of $5,346,756,894.

When we look at daily trading volumes, First Digital USD has 1,387,990,197 FDUSD in trades, surpassing DAI. USDC holds the second position with 2,395,313,402 USDC in trades. USDT leads in both categories, with a trading volume 10 times higher than its main competitors.

The cost of these top stablecoins is pegged to the cost of the US dollar. But the DAI token, unlike its counterparts, is not backed by the U.S. dollar. The ERC20 token is supported by a combination of various crypto assets, including Ethereum. Thus, DAI is a cryptocurrency-collateralized stablecoin, while others are fiat-collateralized ones.

True USD (TUSD), dubbed the ‘first regulated stablecoin,’ is claimed to have full backing by the U.S. dollar. Another noteworthy asset is BUSD (Binance USD). It was developed by renowned partners Binance and Paxos. The BUSD token is also 100% backed by U.S. dollars and treasury bills and often ranks among the top three most popular stablecoins.

So, although there are quite a few different types of stablecoins, the most acclaimed ones are dollar-pegged coins.

Now that we know what coins are stablecoins and what types they come in, it’s time to answer the question: what are stablecoins used for? For without practical value they are useless.

Use Cases for Stablecoins

Stablecoins serve as a stabilizing force in the world of cryptocurrencies. They serve as a secure store of value and a means of transaction, providing traders with a respite from market volatility. Additionally, they play a vital role in the burgeoning field of decentralized finance (DeFi), enabling activities like yield-farming, lending, and liquidity provision. 

Most individuals acquire stablecoins through exchange platforms, while some also have the option to create new coins by depositing the required collateral with the issuing company, such as US dollars with Tether or physical gold with CACHE gold. 

Here’s what you can do with stablecoins: 

• Secure Value: With stablecoins, you can shield yourself from the turbulence of the market. Their stable price ensures confidence for both buyers and sellers, knowing that the value of their tokens won’t experience unpredictable swings in the short term. 
• Global Transfers and Savings: Skip the need for a bank account. Stablecoins can be seamlessly sent worldwide, especially to regions where acquiring US dollars might be tricky or where the local currency lacks stability. 
• Lucrative Ventures: Invest in stablecoins and discover higher potential returns compared to conventional banking offerings. It’s a smart move for those seeking opportunities for growth. 
• Transfer Money Inexpensively: They enable cost-effective transfers, with fees often significantly lower than conventional banking methods. 
• International Money Transfer: Fast processing and low transaction fees make stablecoins an excellent choice for sending money globally. In crypto trading, they address a crucial issue with mainstream cryptocurrencies – their high volatility, making them challenging for routine transactions. 

Stablecoins resolve this by pegging their value to a known reserve currency. Moreover, their stability makes them a functional currency within crypto brokerages, providing a continuous, accessible alternative to cash obtained through traditional banking systems. 

Stablecoins are primarily utilized for two key purposes:

• Facilitating Crypto Trades: Many traders opt for stablecoins to facilitate seamless transactions across diverse cryptocurrencies, bypassing the need to convert crypto to cash. 
• Purchasing Goods and Services on Blockchain Networks: Stablecoins provide an unwavering price, making it easier to buy digital goods in virtual marketplaces where the use of fluctuating cryptocurrencies can be challenging. 

While similar to cash, stablecoins aren’t equivalent. They can be converted to cash and vice versa, but they can’t fully replicate the functions of traditional currency.

The Advantages and Disadvantages of Stablecoins

Stablecoins offer a stabilizing force in the crypto space, catering to a range of use cases. Still, they are not without drawbacks. Let’s check out their strengths and weaknesses.

Advantages of Stablecoins:

• Reduced Volatility: Stablecoins offer a stable value, providing a secure haven amidst the volatile nature of cryptocurrencies like Bitcoin and Ethereum.
• Efficient Cross-Border Transactions: They facilitate swift and cost-effective international money transfers, bypassing traditional banking system delays and fees.
• Accessibility and Inclusion: Stablecoins don’t necessitate a bank account, making them accessible to the unbanked and underbanked populations globally.
• Integral to Decentralized Finance (DeFi): They serve as foundational assets in the burgeoning world of decentralized finance, enabling various activities like lending, liquidity provision, and yield-farming. For instance, DAI plays a pivotal role in various DeFi protocols.

Disadvantages of Stablecoins:

• Potential Lack of Stability: If a stablecoin isn’t sufficiently backed by hard assets, especially cash, it may face a run and lose its peg against its target currency. This was exemplified by TerraUSD’s depegging incident in May 2022 and the depreciation of a real estate-backed US dollar in October of the same year.
• Risk of Illegal Activities: Stablecoins can be exploited for criminal intentions, including funding terrorism. Tether recently took action by freezing 32 crypto wallets linked to illicit activities in Israel and Ukraine. Such incidents underscore the need for stringent measures to curb cryptocurrency-funded criminal activities.
• Centralization Concerns: Some stablecoins are issued and managed by centralized entities, which may raise concerns about transparency, trust, and susceptibility to external control.

While stablecoins serve as an indispensable asset in managing crypto market fluctuations and enabling efficient transactions, they are not without their risks. It is imperative for stablecoin issuers to preserve robust collateralization and for regulatory authorities to enforce compliance to ensure the stability and integrity of these digital assets.

FAQ

How do stablecoins maintain their stability?

Stablecoins maintain stability through collateralization with assets like fiat currencies or commodities. They may also use algorithmic mechanisms or a combination of both, ensuring a stable value in the crypto realm.

Are stablecoins regulated?

Stablecoins are regulated to varying degrees depending on jurisdiction. Some countries have frameworks to ensure compliance and safeguard against potential risks associated with these digital assets.

How can I get stablecoins?

You can acquire stablecoins through reputable crypto exchanges. They are typically available for purchase. Additionally, you can obtain them by participating in DeFi platforms. These platforms offer options for minting stablecoins by providing collateral.

Disclaimer: Please keep in mind that the content of this article is not financial or investing advice. The information provided is the author’s opinion only and should not be considered as direct recommendations for trading or investment. Any article reader or website visitor should consider multiple viewpoints and become familiar with all local regulations before cryptocurrency investment. We do not make any warranties about reliability and accuracy of this information.