The cryptocurrency world has tremendous growth in modern times. In relation to this expansion, the stablecoins market is also equally booming. Undoubtedly, there are numerous videos, blogs, articles, and other online platforms describing what stablecoins are and how they perform in the cryptocurrency market. However, if you are a newbie in the world of cryptocurrency or stablecoins, it’s normal to feel confused by the many terminologies, concepts, and categories that are being described.
Here we highlight every must-know in a more understandable and concise method to the best we can.
Definition of Stablecoins
As a newbie, the simplest and more understandable definition of stablecoins is definitely the most desirable ones. Here are some of the easy-to-understand definitions of stablecoins as an introduction:
- Stablecoins are a type of cryptocurrency whose market price is pegged to another kind of stable asset.
- Stablecoins are a different kind of cryptocurrency developed to reduce stablecoins’ price volatility, associated with a basket of assets or other stable assets.
- Stablecoins are cryptocurrencies developed to preserve a stable market price.
Stablecoins’ basic purpose is to preserve price stability in relation to different types of cryptocurrencies, such as Litecoin, Ethereum, or Bitcoin. In most cases, the purpose of stablecoins like USDC is to maintain a 1:1 valuation with USD. In simple terms, one USDC is equal to one US Dollar.
At the moment, the most basic purpose of stablecoins is to serve as a safe place for cryptocurrency trading. That said, funds can exchange quickly and more conveniently between investment positions and develop leveraged positions without any additional volatility. In simple terms, it is easier to directly sell Bitcoins for TrueUSD or Tether if the value decreases instead of converting them to fiat currencies into your bank accounts, which can usually take one or two days to complete its transaction.
Hence, it is more convenient and real-time to trade stablecoins from one exchange to another to seize arbitrage opportunities. However, it’s nearly impossible with the current banking scheme.
Other publicized use cases of stablecoins include as a potential reserve currency, more stable and improved smart contracts, and peer-to-peer payments. While all future implementations sound promising, all are just a means to an end. It is primarily because when cryptocurrencies expand in usage and popularity, they eventually become more stable and less volatile.
Types of Stablecoins
Stablecoins are essential to the emerging digital currencies and economy as well as bridge the gap between a variety of cryptocurrencies and traditional fiat currencies. In addition, stablecoins are grouped into three major categories.
Crypto-Collateralized stablecoins are backed by other cryptocurrencies. However, since the reserve cryptocurrencies may be prone to high volatility, stablecoins are over-collateralized. That said, a big portion of the issued supply is preserved so a lower number of stablecoins can be distributed. Hence, issuers can maintain price stability.
For example, $3,000 worth of Ethereum can be preserved for issuing $2,000 worth of crypto-backed stablecoins, allowing a maximum of up to 50% of swings in Ethereum. The frequency of audits also supplements price stability as investors can have peace of mind that operations are performing smoothly. A concrete example is MakerDAO’s Ethereum-based DAI. The cryptocurrency platform utilizes a similar system where the stablecoin DAI is pegged against USD, letting a basket of cryptocurrency assets act as a reserve.
Examples of Crypto-Collateralized Stablecoins:
- Money On Chain
Non-Collateralized stablecoins are generally referred to as seigniorage or algorithmic stablecoins. Algorithmic defines how stablecoins’ supply is increased or decreased based on a programming code. In addition, non-collateralized stablecoins utilize algorithmic tools to maintain their price stability. Hence, they aren’t backed by any type of assets. This system is similar to how a central bank prints and destroys traditional bills. Like other stablecoin contenders, the primary objective is to preserve price stability as close as USD1 as possible. On the contrary, non-collateralized stablecoins are the least popular category since they’re very complicated. Lastly, they have a late introduction to the stablecoins market.
Examples of Non-Collateralized Stablecoins:
Fiat-Collateralized stablecoins maintain fiat currency reserves similar to the US Dollar that acts as collateral to issue numerous tokens. Other types of collateral include precious metals, such as silver and gold, and other products like oil. However, the majority of fiat-collateralized US Dollar stablecoins utilize dollar reserves.
In addition, fiat-collateralized stablecoins are maintained by third-party custodians. Hence, they are frequently audited by central banks for regulations and compliance. Some of the popular stablecoins are USDC and USDT (Tether), with each stablecoin containing a value equivalent of USD1 and backed by dollar reserves. The sole difference is these stablecoins’ deposits/reserves – USDC is backed by USD1 saved in a bank account while USDT is backed by a basket of different assets and reserves.
Examples of Fiat-Collateralized Stablecoins:
- Gemini Dollar
- USD Coin
As mentioned, stablecoins are cryptocurrencies whose market value is pegged to another stable asset where the most popular use maintains with cryptocurrency traders who frequently utilize it as a safety net for arbitrage prospects.
In addition, stablecoins are crucial features of the emerging cryptocurrency world. This type of cryptocurrency advocates booming implementation as a sustainable hedging mechanism for a diverse range of financial products. However, due to stablecoins’ fresh development, there is so much more to improve, experiment, and develop. The fundamental use cases for stablecoins provide an opportunity as a foundational component, bridging the gap between old and new financial systems.