The cryptocurrency industry is struggling with regulatory challenges and wide price fluctuations. Stablecoins are supposed to be the prescription for both problems. What is stablecoin? What is it used for and how to use it? Here’s a quick guide through the world of stablecoins.
Authorities, regulatory organizations and banks are still quite reluctant to deal with cryptocurrencies, especially because of their controversial past. Thus, trading and sometimes even owning virtual money is prohibited in many countries. However, the crypto industry wants to grow, so to bypass the bans and make it easier to use digital assets, stablecoins were created.
Stablecoin – what is it?
The rise of Bitcoin at the end of the previous decade allowed us to look at the financial market from a completely different perspective. What we previously knew as the only financial system gained a serious digital competitor. Since 2010, hundreds of new cryptocurrencies have been created.
Relatively quickly, however, problems were discovered that prevent digital money from gaining mass adoption. Besides the affair and scandals, which are mostly a thing of the past, one of the biggest challenges is the price volatility of cryptocurrencies. This is what stablecoin is meant to prevent.
Stablecoins, or a cryptocurrency oxymoron
Stablecoin is a cryptocurrency that maintains a stable value relative to an established external asset class. It aims to minimize price volatility by maintaining its value relative to that of traditional real-world assets, such as a single fiat currency, a combination of currencies, or a valuable real-world commodity (e.g., oil, gold).
The main goal of stablecoin is to negate the speculative nature of most cryptocurrencies and help create a more consistent and reliable market environment to increase the adoption of digital assets.
4 types of stablecoins
Stablecoins are most often backed by fiat currencies. The largest stablecoins are backed by the unofficial world currency, the US dollar (USD). For the past few years, more and more stablecoins have been created backed by the euro (EUR), the British pound (GBP), the Japanese yen (JPY), or even goods traded on asset exchanges.
There are four main types of stablecoin:
- Fiat-backed – The most common type of stablecoin. These are cryptocurrencies backed by real-world currencies (such as the dollar). Among them are Tether (USDT), Binance USD (BUSD), USD Coin (USDC) etc.
- Commodity-backed – Based on real-world commodities such as oil, gold and silver. Among them are PAX Gold, Digix etc.
- Backed by cryptocurrencies – Stablecoins that are backed by other cryptocurrencies (e.g. ETH, BTC). These include the DAI token, WBTC, EOSDT, among others.
- Unsecured by assets (algorithm-based) – These stablecoins are not backed by either real or digital assets, and instead depend on a complex combination of algorithms and smart contracts to maintain a stable price by buying and selling stablecoin and manipulating its supply. This group includes UST, USDD, USDN etc.
A brief history of success
The first stablecoins were issued back in 2014. BitUSD, which is considered to be the first stablecoin, was linked to other cryptocurrencies rather than traditional currencies.
The end of 2014 also saw the creation of Tether (USDT), which is the most important, largest, and best-known stablecoin in the world. It wasn’t until 2015 that it went public on the Bitfinex exchange (with which, as it later turned out, it is affiliated, something that was tried to be scrupulously hidden) and the crypto-world got to know a new tool in the industry.
Tether has been controversial almost from the beginning, often finding itself under the magnifying glass of US law enforcement agencies. Nevertheless, Tether dominated the stablecoin market. Today there are more than 84 billion USDT in circulation (each worth about $1).
The chart above shows the growth of stablecoin capitalization and the dominance of Tether itself (green colour) in the market. Today, USDT is the third largest cryptocurrency in the world (after Bitcoin and Ethereum).
According to Coingecko, as of today, there are 92 stablecoins. Half of the active stablecoins are based on the Ethereum blockchain.
Differences and similarities
Each stablecoin is unique in concept, but it shares many characteristics in common with other stablecoins:
- it is backed by any type of asset
- It controls the supply of circulating funds
- seeks to maintain a constant value in the real world.
While stablecoins are one type of cryptocurrency, they are very different from other types of digital money:
- stablecoins most often undergo audits by independent authorities to ensure that they actually hold the funds with which they are backed, thus inspiring confidence
- stablecoins are not speculative in nature (unlike other cryptocurrencies)
- stablecoins are much more centralized and controlled than other cryptocurrencies.
Use cases of stablecoins
For many traders, stablecoins serve as a lifeboat with which to escape the falling prices of their assets. As soon as their analysis shows that crypto prices are likely to fall, they swap their BTC, ETH, etc. for USDT, BUSD, USDC etc. and wait out the downturn. When they know that the price has already reached a bottom, they swap their stablecoins into cryptocurrencies again.
Many exchanges use stablecoins as replacements for fiat money. This is because regulatory restrictions often prevent exchanges from introducing fiat currencies on their platforms. However, no one prohibits the use of cryptocurrencies that act as fiat currencies, are backed by them, and most often have a 1:1 ratio to traditional currencies.
Another major application is expected to be the use of stablecoins in DeFi (decentralized finance – a blockchain alternative to the existing financial system that has become popular in the past years).
Stablecoins, however, have the potential for much greater adoption. According to a Consensys report, here are some examples from everyday life where stablecoins could be useful:
- Salaries and rent or other recurring payments
- Transfers to cover price differences during payment processing
- Trading and wealth management
- Store of value for long-term hedging needs
- Daily trade payments between companies in different countries.