What is a Stablecoin?

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Cryptocurrencies such as bitcoin and ether come with a host of benefits, one of which is the trust and privacy they provide for every transaction. Cryptocurrencies removed the need for any intermediary institution when sending or receiving payments, hence opening up their use to anyone around the globe.

However, one major drawback for cryptocurrencies is that they are particularly considered volatile investment instruments because of their unpredictable price. Prices of cryptos fluctuate a lot – rising and falling too often. Because of that, it is difficult to use them for everyday goods and services.

On the other hand, fiat currencies such as U.S dollars or other assets like gold have a more stable price. But they don’t provide the same level of privacy and security offered by cryptocurrencies. That is where stable coins come in. They attempt to offer the best of both worlds – providing the security and privacy of cryptocurrencies and the price stability of fiat currencies.

What is a Stablecoin?

Stablecoins are cryptocurrencies that are pegged to an underlying asset like the U.S dollar or a precious metal such as gold. These types of coins are designed to reduce the volatility associated with unpegged cryptocurrencies like Bitcoin.

Unlike cryptocurrency whose price fluctuates and is also very unpredictable, the price of a stablecoin remains steady, in accordance with whichever fiat currency or asset backing it. Stablecoins can be used as a store of value or units of accounts, as well as for other purposes where cryptocurrencies may be less desirable because of their volatility.

Better Understanding of the Concept behind Stablecoins

Although Bitcoin is the first and most popular cryptocurrency, it tends to suffer from high price volatility. For example, in November 2019, the coin rose in price from around $5,950 to above $19,700 in December that same year. But by early February 2020, the price dropped again to about $6,900. This is not uncommon to Bitcoin and other cryptocurrencies – they tend to move in any direction based on supply and demand.

Because of this kind of short-term volatility, cryptocurrencies become unsuitable for everyday use by the public. Generally, anyone would expect a currency to act as both a medium of monetary exchange and a mode of storage of monetary value. Plus, the value of such currency should remain stable over a relatively long period of time. Who would want to adopt a currency they are not sure will retain its purchasing power tomorrow? Stablecoins come to provide a solution to achieve this ideal behavior.

Because stablecoins are backed by fiat currencies and some reserve authorities that help to control the price, they tend to be more stable in price than cryptocurrencies. They are immune against the usual value swings that do happen in the crypto world – thanks to the controlling authorities that ensure the prices remain stable by helping to manage the demand and supply of the currency.

Different Types of Stablecoins

Fiat-collateralized stablecoins

These types of stablecoins are backed by fiat currency reserves, such as the U.S dollar, as collateral to ensure a suitable number of the coins are issued. There could also be other forms of collateral backing stablecoins such as gold, silver, oil. However, most of the present-day fiat collateralized stablecoins are backed by the U.S dollar reserve. A good example of such stablecoin is Tether (USDT) and TrueUSD.

Crypto-collateralized stablecoins

These stablecoins are backed by other cryptocurrencies. Because the reserve cryptocurrencies are also prone to high volatility, they are usually backed by a whole lot of the backing cryptocurrency which is maintained as a reserve for issuing a lower number of the stablecoin. For instance, $3000 worth of ether may be held as reserves for issuing $2000 worth of crypto-backed stablecoins.

Non-collateralized stablecoins

These types of stablecoins are also called algorithmic stablecoins. They don’t use any reserve but retain a stable price using a working mechanism, like that of a central bank. For instance, an algorithmic stablecoin, basecoin, uses a consensus mechanism to maintain the supply of tokens based on demand. Most of these stablecoins use a smart contract on a decentralized platform that can run in an autonomous manner.

What Are The Most Popular Stablecoins?

#1: Diaem (Libra)

Libra is a stablecoin originally conceived by Facebook. Although the coin is yet to be launched, it has had more psychological impact than any other stablecoin. In fact, China’s government is planning to create their own crypto-inspired digital currencies because they are scared of how much of a competitive threat Diem would be when it is eventually launched. They are scared because the coin is owned by Facebook which is a multinational company with billions of users across the globe.

#2: Tether (USDT)

Launched in 2014, Tether is one of the oldest stablecoins and also the most famous. The stablecoin is claimed to be backed by a reserve of real dollars as collateral locked up somewhere in a physical location controlled by a centralized third party.

That way, investors can be more confident investing in the coin because they are sure that their tethers really are worth one dollar each. That means there is great stability with the price of the coins. So if you are thinking of whether to buy Tether and add it to your portfolio, it might just be a wise decision.

#3: USD coin (USDC)

This stable coin was launched in 2018. It is jointly managed by cryptocurrency firms Coinbase and Circle via the Centre Consortium. USD Coin is backed by U.S dollars and has about $26 billion of it in circulation. In a recent investor presentation, Circle stated that people should expect to see USD Coin supply touch $190 billion by 2023.

#4: Dai (DAI)

Dai is a stablecoin created in 2015 and runs on the Ethereum blockchain. The coin is pegged by U.S dollar and backed by ether. Unlike other stablecoins, Dai is designed to be a decentralized coin. That means it won’t be controlled by any central authority. Instead, it will be run and maintained by Ethereum smart contracts.

#5: Terra (LUNA)

This is also a decentralized stablecoin. Instead of it being controlled by and protected by a third party, it uses a complex algorithm to get the job done. With the use of smart contracts, it is able to balance “on-chain” reserves with supply and demand automatically, removing the chances of any trader tampering with the price.

Some More Popular Stablecoins You Should Know

  • Ampleforth (AMPL)
  • CACHE gold (CACHE)
  • Gemini Dollar (GUSD)
  • True USD (TUSD)
  • Paxos Standard (PAX)
  • Binance USD (BUSD)
  • Stasis Euro (EURS)
  • Petro (PTR)
  • Paxos Gold (PAXG)
  • Paxos Standard (PAX