Stablecoins are cryptocurrencies where the price is stable, unlike leading cryptocoins like Bitcoin and Ethereum.
Stablecoin price is fixed or constant and does not observe a very high rise or fall in value every second. Stablecoin price is designed to be pegged to a cryptocurrency, fiat money, or exchange-traded commodities.
Types of Stablecoins
In today’s market stablecoins are of three types:
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Fiat Backed stablecoin
The value of stablecoins of this type is based on the value of the backing currency, which is held by a third-party regulated financial entity. In this type of backing, the trust in the custodian of the backing asset is crucial for the stability of the price of the stablecoin.
Fiat-backed stablecoins can be traded on exchanges and are redeemable from the issuer. The cost of maintaining the stability of the stablecoin is equivalent to the cost of maintaining the backing reserve and the cost of legal compliance, maintaining licenses, auditors, and the business infrastructure required by the regulator.
Cryptocurrencies backed by fiat money are the most common and were the first type of stablecoins on the market. Their characteristics are:
- Their value is pegged to one or more currencies (most commonly the US dollar, also the Euro, and the Swiss franc) in a fixed ratio,
- The Stablecoin is realized off-chain, through banks or other types of regulated financial institutions which serve as depositaries of the currency used to back the stablecoin,
- The amount of the currency used for backing the stablecoin has to reflect the circulating supply of the stablecoin.
Examples: TrueUSD (TUSD), USD Tether (USDT), USD Coin, Diem.
Cryptocurrency-backed stablecoins are issued with cryptocurrencies as collateral, which is conceptually similar to fiat-backed stablecoins.
However, the significant difference between the two designs is that while fiat collateralization typically happens off the blockchain, the cryptocurrency or crypto asset used to back this type of stablecoins is done on the blockchain, using smart contracts in a more decentralized fashion.
Significant features of crypto-backed stablecoins are:
- The value of the stablecoin is collateralized by another cryptocurrency or a cryptocurrency portfolio,
- The peg is executed on-chain via smart contracts,
- The supply of the stablecoins is regulated on-chain, using smart contracts,
- The price stability is achieved through the introduction of supplementary instruments and incentives, not just the collateral.
Live stablecoins projects of this type are Havven (the pair: nUSD – stablecoin and HAV – the collateral-backed nUSD), DAI (pair: CDP – Collateralized Debt Position and MKR – governance token used to control the supply, and others. There is also Wrapped Bitcoin (WBTC), see BitGo.
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The main characteristics of backed stablecoins are:
- Their value is fixed to one or more commodities and redeemable for such (more or less) on demand,
- There is a promise to pay, by unregulated individuals, agorist firms, or even regulated financial institutions,
- The amount of commodity used to back the stablecoin has to reflect the circulating supply of the stablecoin.
Holders of commodity-backed stablecoins can redeem their stablecoins at the conversion rate to take possession of real assets. The cost of maintaining the stability of the stablecoin is the cost of storing and protecting the commodity backing.
: Digix Gold Tokens (DGX) and others.
Not backed – Seigniorage-style Stablecoin
Seigniorage-style coins utilize algorithms to control the Stablecoin’s money supply, similar to a central bank’s approach to printing and destroying the currency. Seigniorage-based stablecoins are a less popular form of stablecoin.
Significant features of seigniorage-style stablecoins are:
- Adjustments are made on-chain,
- No collateral is needed to mint coins,
- Value is controlled by supply and demand through algorithms, stabilizing price.
The Basis was one example of a seigniorage-style coin.
Is it more stable than Bitcoin or Ethereum?
Stablecoin being an alternative to state-issued money, the likes of Tether and USD Coin are pegged to government-backed legal tender such as the dollar. These tokens allow investors to switch into and out of their cryptocurrency assets without having to interact each time with a bank wary of unwittingly enabling money-laundering, terror financing, child pornography, or extortion hacking.
Payment networks like Visa Inc. allow customers to settle claims using USD Coin, stablecoins have begun to acquire mainstream appeal.
In China, the monetary authority’s pilot has at least made a modest start, distributing the equivalent of $40 million of digital yuan via lottery ahead of an expected debut around next year’s Beijing Winter Olympics. Most other major central banks are nowhere near coming up with their own official digital cash for widespread, public use.
Possibilities ahead for stablecoins.
Funds parked with Tether have grown by 230% this year, according to Fitch Ratings, which reckons that on current trends, stablecoins could become a bigger holder of short-term U.S. commercial paper than money market mutual funds in two or three years.
While Diem, the upcoming, Facebook-backed stablecoin, has said that it will invest predominantly in government securities, alternative allocation strategies are possible and, “depending on its scale, the operator may become an important participant in other short-term markets,” Fitch says.
Stakes are high for overall financial stability, especially if a large number of people decide to simultaneously cash out of a popular stablecoin amid skepticism about its true exchange value.
Money is valuable only when those who have it and those who want it in exchange for something else aren’t plagued by unnecessary doubts. The researchers recently drew a parallel with the pre-Civil War era of wildcat banking, when a Tennessee lender’s banknotes were discounted by as much as 20% in Philadelphia.
Stablecoins are here to stay. Since they provide liquidity and a perceived “safe haven” for investors during times of heightened crypto volatility, their recent growth spurt to continue, at least as long as the overall market for digital tokens is expanding. Central banks’ own paperless cash may, therefore, have to learn to coexist with private money.
So we can say that Stablecoins are more stable than Bitcoin or Ethereum. One can invest in it without having any fear of great loss or profit. You can purchase Stablecoin from all leading crypto trading exchanges such as Binance, Coinbase, and Bybit
Also check About the different types of cryptocurrencies