What is Stablecoin?: Meaning, Types, Need, How to Invest, and more!

You may be wondering what is a stablecoin with all the talk about crypto regulatory entities enacting or prohibiting stablecoin rules. Right? That is, after all, why we are here. "Stablecoin" is a cryptocurrency whose value is tied to another asset class, such as fiat currency or gold, in order to keep its price stable.

One of the most fundamental advantages of cryptocurrencies like bitcoin and ether is that sending payments does not require confidence in a third party, making them available to anybody in the world. However, a significant disadvantage of cryptocurrencies is their unpredictability and propensity for dramatic price fluctuations.

What is Stablecoin?

A cryptocurrency is referred to as "stablecoin" if its value is linked to another asset class, such as fiat money or gold, in order to maintain price stability. Sending payments does not involve trust in a third party, which makes cryptocurrencies like bitcoin and ether accessible to everyone in the world. This is one of their most fundamental features. However, the unpredictability and propensity for sharp price changes of cryptocurrencies is a serious drawback.

They are therefore challenging for regular people to utilize. For their security and livelihood, individuals often expect to be able to predict what their money will be worth in a week.

In contrast to the relatively constant pricing of other assets, like gold, or fiat money, like U.S. dollars, cryptocurrency prices are unpredictable. While the values of currencies like the dollar do move steadily over time, the daily swings in cryptocurrency values, which increase and fall often, are frequently more abrupt. In this course, you will see what is Stablecoin, what are its types, and how significant it is to the cryptocurrency industry. So, let us begin!

Stablecoins: How are they used?

Stablecoins are largely utilized as a form of exchange and a store of value, like the majority of digital assets. When the market is in a downward spiral, they provide traders with a little respite from volatility. They may also be utilized in the rapidly expanding decentralized finance (DeFi) industry for activities like yield-farming, lending, and liquidity supply.

However, it is sometimes feasible to create brand-new stablecoins by depositing the necessary collateral with the issuing corporation, such as US dollars with Tether or actual gold with CACHE gold. Stablecoins are most commonly acquired by traders and investors through the purchase of them from exchange platforms.

Types of Stablecoins

Given the widespread acceptability and availability of the U.S. dollar, some people would argue that stablecoins are a problem in search of a solution. On the other hand, many supporters of cryptocurrencies think that decentralised digital money will rule the future. Based on the method used to maintain its value, there are three different kinds of stablecoins.

Source: Tasty Crypto

Fiat-Collateralized Stablecoins

Stablecoins that are "fiat-collateralized" keep a reserve of a fiat currency (or currencies), such as the dollar, as security for the stablecoin's value. Other types of collateral can be commodities like crude oil or precious metals like gold or silver, however the majority of fiat-collateralized stablecoins have U.S. dollar reserves.

These reserves are frequently audited and are kept up by independent caretakers. Popular stablecoins Tether (USDT) and TrueUSD (TUSD) are pegged to the dollar and backed by U.S. dollar reserves.

Crypto-Collateralized Stablecoins

Stablecoins with cryptocurrency collateral are supported by other cryptocurrencies. Such stablecoins are overcollateralized, meaning that the value of cryptocurrency kept in reserves exceeds the value of the stablecoins issued, because the reserve cryptocurrency may be subject to severe volatility as well.

To protect against a 50% drop in the price of the reserve cryptocurrency, a cryptocurrency worth $2 million may be retained as reserve in order to issue $1 million in a stablecoin backed by cryptocurrency. For instance, MakerDAO's Dai (DAI) stablecoin is backed by Ethereum (ETH) and other cryptocurrencies worth 150% of the DAI stablecoin in circulation while still being linked to the U.S. dollar.

Commodity-Collateralized Stablecoins

Digital currencies backed by tangible assets like gold, oil, or other commodities are known as commodity-backed stablecoins. Physical assets such precious metals, oil, and real estate are used as security for commodity-backed stablecoins. Gold is the most common commodity to be collateralized, and two of the most liquid stablecoins backed by gold are Tether Gold (XAUT) and Paxos Gold (PAXG).

Algorithmic Stablecoins

Stablecoins that use algorithms could or might not have reserves. Their main difference is how a stablecoin maintains its value by using an algorithm to restrict its supply, which is effectively a computer programme that follows a predetermined formula.

That's similar to central banks in other ways as they also don't depend on a reserve asset to maintain the stability of the value of the currency they issue. The distinction is that a central bank, such as the United States Federal Reserve, establishes monetary policy openly based on accepted guidelines, and the legitimacy of that policy is greatly enhanced by its role as the issuer of legal money.

What stablecoins are most in demand?

Let's go over some of the most well-known stablecoins to give you an idea of the experimenting taking place in stablecoin realm.

Tether

Since its debut in 2014, Tether (USDT) has been one of the most widely used stablecoins. According to market capitalization, it is one of the most valuable cryptocurrencies overall.

Moving money swiftly between exchanges to take advantage of arbitrage possibilities arises when the price of cryptocurrencies varies on two exchanges; traders may profit from this differential. This is the main use case for USDT. But it has also been used in other contexts: Additionally, Russian-based Chinese importers have utilised USDT to move millions of dollars' worth of goods across the border, evading China's tight cash restrictions.

The business that issues USDT, Tether Ltd., was involved in a 22-month legal fight with the New York Attorney General on claims that Bitfinex, a sister company of Tether, attempted to use assets seized from Tether to cover up a $850 million shortfall.

Finally, on February 23, 2021, the lawsuit was resolved, and Tether and Bitfinex were ordered to pay $18.5 million and provide quarterly reports outlining Tether's stablecoin reserves for the following two years.

USD Coin

Through the Centre Consortium, cryptocurrency companies Circle and Coinbase together released USD Coin, a stablecoin, in 2018.

Similar to tether prior to its switch to a variety of collateral assets, USD Coin is tied to the dollar. Given that USDC is an open-source protocol, anybody or any organisation can utilise it to create their own products.

Circle announced on July 8, 2021, that it will IPO via a $4.5 billion SPAC merger with Concord Acquisition Corp. The information was released a month after Circle announced the completion of a $440 million fundraising round that included well-known business players including FTX, Digital Currency Group, and Fidelity Management and Research Company.

OneFIL (Filecoin)

OneFIL was created by ICHI, a system for establishing "decentralised money authorities," and it serves as the Filecoin network's stablecoin. It is backed by the native coin of Filecoin, FIL, and USDC. In addition to offering incentives and discounts for Filecoin storage purchasers and providers, its goal is to create a stablecoin for the further expansion of the Filecoin network.

Dai

Dai is a stablecoin on the Ethereum blockchain that utilises the MakerDAO system. Dai, a 2015 creation, is backed by ether, the cryptocurrency that powers Ethereum, and is exchanged for dollars.

Unlike previous stablecoins, MakerDAO wants dai to be decentralised, which means there won't be a single entity in charge of it. Rather, this function is performed by Ethereum smart contracts, which store immutable rules.

However, there are still issues with this novel approach, such as when the MakerDAO's underlying smart contracts fail to perform as expected. In fact, they were cheated in 2020, resulting in $8 million in damages.

Why are stablecoins used in cryptocurrency trading?

One of the biggest issues with many popular cryptocurrencies is that they are difficult, if not impossible, to use for actual transactions. Stablecoins address this issue.

"Digital currencies like Bitcoin and Ethereum are tremendously volatile, which makes pricing things in their terms very difficult," claims Anthony Citrano, creator of Acquicent, a marketplace for NFTs. "By tying the prices of stablecoins to a recognised reserve currency, they avoid this problem."

Many stablecoins can also be utilised as a useful currency within a cryptocurrency brokerage thanks to their stability. For instance, rather of converting Bitcoin to dollars, traders may do it into a stablecoin like Tether. Stablecoins are more readily available than currency earned through the banking system, which is shut down during the weekend and overnight.

Additionally, stablecoins may be utilised with smart contracts, a type of electronic contract that automatically executes when all of its conditions are met. The digital currency's steadiness also aids in avoiding disputes that could develop when dealing with more volatile cryptocurrencies.

What distinguishes stablecoins from other cryptocurrencies?

The most well-known cryptocurrencies in the world, such as Bitcoin and Ethereum, are referred to as "free-floating crypto," which indicates that they behave like commodities and get their value from the asset's supply and demand market.

They can experience high price fluctuation since the value of these assets is not dependent on any other asset or algorithm.

This implies that investors would purchase cryptocurrencies like BTC and ETH expecting that their investments would experience high volatility. However, stablecoins always maintain a value equivalent to that of a more conventional asset, giving investors new alternatives. These may consist of:

Market Consistency

Stablecoins are distributed in accordance with the economics and conditions of the market, unlike regular cryptocurrencies which have a set schedule and restricted quantity. To assist investors protect themselves from market declines among more conventional cryptocurrencies, these assets are backed by collateral.  This makes stablecoins a particularly valuable asset for traders, and it's not unusual to see significant trading volumes move into Tether when a brief market downturn in assets like Bitcoin is predicted. Additionally, certain exchanges, like as Bitfinex, demand that customers buy Tether before exchanging their holdings for other assets.

Suggest Venture Capital

Stablecoins also have the potential to get a significant inflow of venture capital funding.  Although this may appear contradictory to VCs, it is doubtful that investors would profit from purchasing stablecoins due to the absence of volatility. Venture capitalists and retail investors have improved opportunities to make investments and construct successful portfolios as a result of the creation of new business models related to the stablecoins market.

Possibilities for Benefits

Stablecoins may sometimes produce larger returns than conventional bans would, and there are methods for investors to profit just by holding them.  For instance, USD Coin provides up to 4% in return for stakes, while less popular stablecoins like USDD might provide up to 8%.

Low-Cost International Transactions

Another major benefit of stablecoins is that you may send money anywhere in the globe without having to deal with exchanging fiat currencies or incurring exorbitant fees thanks to their infrastructures for quick processing and minimal transaction fees.  It's important to note that transmitting large sums of money might result in comparatively negligible expenses when discussing cheap fees. For instance, according to Coinbase, some people have sent more than $1 million in USD Coin with transfer costs around $1.

In conclusion, stablecoins provide stability across the cryptocurrency ecosystem in a manner that standard crypto can't. They are great instruments for traders navigating unpredictable markets and individuals in need of refuge from a crypto slump because to their minimal transaction fees and traditional asset collateralization. It's crucial to emphasise that there are some risks in the stablecoin ecosystem.

Leading stablecoins like Tether have already encountered controversy concerning the stability of the assets. Stablecoins may appear to be risk-free investments, but they are in fact not immune to risk and might encounter difficulties when the larger crypto ecosystem is going through a testing phase.

Can You Invest in Stablecoins?

A particular type of cryptocurrency is called a stablecoin. They are poor financial decisions. They are more suited to online transactions and the exchange of digital assets for "real" money. Exchanging coins for Stablecoins may be simpler, quicker, and less expensive than exchanging coins for actual dollars in and out of your bank account because of how quickly cryptocurrency trading and prices vary.

For instance, your Bitcoin would still be available on the exchange you are using and would retain its value if you converted it to USDT, a Stablecoin tethered to the US dollar. After then, the Stablecoins may be traded for other coins. Directly converting your Bitcoin to US dollars might delay its arrival at your bank account and keep it off the cryptocurrency market.

Where Can You Buy Stablecoins?

• You'll need a cryptocurrency exchange account or a digital wallet to buy crypto directly in order to purchase Stablecoins.
• Some Stablecoins could be offered on centralised exchanges like Coinbase, although these exchanges might only show versions backed by money.
• Any current tokens may be exchanged for the majority of stablecoins on a decentralised exchange in exchange for more options.

Stablecoin Drawbacks

Now you know What is Stablecoin, and its significance but you should also know the drawbacks that come along. Investors require evidence that the reserves backing the coins exist. In the case of Tether, this has never been unambiguously demonstrated, giving rise to rumours that the currency was not supported and was instead created out of thin air.

Not all stablecoins are stable. As speculators poured money into it, the Gemini Dollar rose a few pennies multiple times in the previous year. Ironically, a large portion of the money used by those investors had originated from Tether, which had previously fallen to as low as $0.51 on certain exchanges. In light of this, stablecoins might be viewed as "relatively" stable rather than completely stable—especially when contrasted to volatile assets like Bitcoin.

Less than 3% of Tethers were truly backed by cash, despite Tether's repeated claims that it is 100% backed by US dollars. In May, Tether provided a breakdown of its reserves for the first time in seven years.

Additionally, US politicians are not generally fond of stablecoins. Stablecoins require more regulation, according to Federal Reserve chairman Jerome Powell, who stated this previously in his semi-annual monetary policy report to Congress.

Conclusion

Most cryptocurrencies lack stability, which prevents them from being used as genuine money. Stablecoins fill this gap. However, users of stablecoins should be aware of the hazards involved before utilising them. Stablecoins may appear to have little hazards in ordinary situations, but at times of crisis, when owning them should be the safest, they may become the riskiest.

Stablecoin FAQs

What Is Stablecoin Used For?

The significant volatility of well-known cryptocurrencies, such as Bitcoin (BTC), which might make cryptocurrencies less appropriate for routine transactions, is the main goal of stablecoins.

What is the Stablecoin Process?

Stablecoins make an effort to link their market value to an outside standard, often a fiat currency. They function better as a means of exchange than more volatile cryptocurrencies. Stablecoins can be linked to the price of gold or another commodity, such as the U.S. dollar, or they can utilise an algorithm to regulate production. Additionally, they keep reserve assets on hand through the use of algorithmic supply-controlling methods or as collateral.

Which Stablecoin Is the Best?

Tether (USDT) is the most widely used and valuable stablecoin in terms of market capitalization. It is backed by gold reserves and tied at a 1:1 ratio to the US dollar. It frequently ranks among the top five cryptocurrencies in terms of market cap. Tether is available on the majority of the main cryptocurrency exchanges, including as Kraken, Binance, and Coinbase. 

Is Stablecoin Such a Big Deal?

Stablecoins maintain some of the most beneficial characteristics of non-pegged cryptocurrencies but lack their volatile nature.

• Stablecoins are open, accessible, and available to everyone online, round-the-clock.
• They deliver data rapidly, affordably, and safely.
• They are internet-native and programmable.