Photo courtesy Art Rachen on Unsplash.
Stablecoins are a type of cryptocurrency whose market value is tied to an external asset to stabilize its price. They may be pegged to a fiat currency like the US dollar, or even to a commodity like gold.
The price of cryptocurrencies is very volatile and fluctuates wildly. It is very difficult to predict what its value would be a week or a fortnight from now. This is in sharp contrast to gold or the dollar whose prices fluctuate but not at such a rapid pace. Therefore it is difficult to bring cryptocurrencies to everyday use.
The expectation from a currency is to serve as storage of monetary value and its price should remain stable over a longer period of time. The people would not like to use it if they are unsure of its purchasing power.
Stablecoins provide a solution to this problem. They tie up to other more stable assets which are generally the fiat currencies like the Dollar or the Euro. The entity behind the stablecoin will keep collateral equal to the value their cryptocurrency is pegged to. The collateral asset backing the stablecoin is generally kept in a brick and mortar bank and it may be paper money, commodity, or the basket of cryptocurrencies. Some stablecoins are just backed by an algorithm. The best stablecoins are the ones that are more stable, provide adequate transparency and keep their collateral amount replenished.
Types of Stablecoins-
The types of stable coins are-
1) Fiat backed-
The fiat-backed stablecoins have a fiat currency reserve as collateral that is maintained by third-party independently regulated financial entities. They are audited for all the required compliances. The cost of maintaining the stability of the stablecoin is equal to the cost of maintaining the reserve plus the legal compliances, auditing, maintaining licenses, and the associated infrastructure. Their value can be pegged to the US dollar, the Euro, Yen, Pound or the Swiss Franc in a fixed way.
2) Commodity backed –
The commodity-backed stablecoins are the ones whose value is tied to precious commodities such as gold and silver. The cost of maintaining the stability of the stablecoin is the cost of storing the commodity that is backing it.
3) Crypto backed-
The crypto-backed stablecoins are the ones that are backed by other cryptocurrencies like Bitcoin and Ethereum that have a large market capitalization. The collateralization is done on the blockchain using smart contracts. As the crypto market is very volatile large collateral is maintained to ensure stability.
4) Non-Collateralized stablecoins-
The non-collateralized stablecoins are not backed by any asset but utilize algorithms to adjust the supply and demand of the stablecoin. These are a less popular form of stablecoin and the adjustments are made on-chain.
Comparison between Bitcoin and Stablecoins-
Bitcoin is the first digital currency that was released in 2008 and is decentralized. Stablecoins are relatively newer cryptocurrencies whose value is fixed and they are used in many real time industries.
A comparison between Bitcoin and stablecoins-
1) Stablecoins are stable and fluctuate less in value while Bitcoin is highly volatile and its market value keeps on fluctuating.
2) The volatility in the price of Bitcoin make them unfit for business as well as real-life transactions while stablecoins are suitable for business transactions.
3) Bitcoin is decentralized while the stablecoins are centralized.
4) Stable coins can be used in real-life transactions while Bitcoin is used for gambling, trading, and payments
5) The reduced volatility in crypto reduces the chances for an investor’s profits but the funding by venture capitalists in stablecoins may be due to new business models being developed.
Some popular stablecoins are-
Tether (USDT) is one of the most popular stablecoins that is hosted on the Ethereum blockchain and the tokens are issued by Tether Limited. It is designed to be worth the US $1.0 and maintains $1.0 in reserves for every Tether issued. The main use of Tether has been to move money between exchanges quickly to take advantage of the arbitrage opportunity that arises between cryptocurrencies. Though the most popular stablecoin, the working of Tether has not been too transparent and they were forced to pay $18.5 million to settle a legal battle with the New York Attorney General.
The USD Coin (USDC) is a digital stablecoin that was launched in 2018 and is pegged to the United States dollar. It is run by a consortium called Centre and has members from cryptocurrency exchange Coinbase and Bitmain(a Bitcoin mining company). USDC runs on the Ethereum, Solana, Tron, Stellar, and Algorand systems. The USDC publishes regular reports regarding results from third-party audits and is quite trustworthy.
Dai is regulated by MakerDao a decentralized autonomous organization (DAO) and is a stablecoin that aims to keep its value close to the US $ 1.0. This is done through an automated system of smart contracts on the Ethereum blockchain. MakerDao intends Dai to be decentralized with no central authority to control the system; with the Ethereum smart contracts performing the job.
Paxos Standard Token-
Paxos Standard Token(PAX) is a stablecoin that runs on Ethereum. Paxos Trust Company is the company managing PAX and holds reserves that back each PAX. It is built on the ERC20 protocol. PAX has a complete decentralized accounting system for its stablecoin. It is regularly audited by various accounting firms and their reserves are also regularly verified.
Applications of stablecoins and their benefits-
- Stablecoins can be used just like the fiat currencies for daily transactions.
- Stablecoins can be used in automatically executing smart financial contracts between two counterparties without requiring a third or a central authority to manage it. The transactions are transparent and traceable.
- The investors are able to access stablecoins by downloading wallets for desktop or mobile and they can do it from anywhere where there is an availability of internet connection.
- Migrant workers who go to different countries for work can easily transfer money to their home countries through digital wallets and send and receive stablecoins. This is unlike the complex system now which takes much longer time for transfer of money and there is a high fee involved for the transfer.
- In some country the fiat currency crashes in value. The locals would be able to exchange their currency for a stablecoin before they lose their savings.
Blockchain is a trustworthy decentralized platform where everyone is equal and it is not controlled by anyone. It can be a faster medium of financial transfer when people are staying in different countries as compared to the fiat currency and with lesser fees involved. The stable coins are much more efficient and not all the cryptocurrency exchanges support fiat currencies which leave stablecoins as the only option. In countries where there is hyperinflation people can purchase stablecoins to protect their wealth.