What is a stablecoin? A stablecoin is a digital asset whose value doesn’t fluctuate in relation to an externally pegged traditional asset class. By securing its value against a traditional asset, stablecoin lowers price volatility. A group of currencies, a single fiat currency, or other priceless assets could serve as the backing asset.
Table of Contents
• What areStablecoins?
• Different kinds of Stablecoins
• What are Stablecoins used for?
• How to keep Stablecoins stable
• Hybrid Stablecoins
• Non-collateralized or seigniorage-style stablecoins
• Conclusion
What are Stablecoins?
Stablecoins are designed to make the adoption of cryptocurrencies more secure and trustworthy while reducing the speculative nature of digital assets. They provide the steadiness of fiat currency with the security and decentralization of cryptocurrencies.
Since the beginning, cryptocurrencies have been seen as extremely price-volatile investment vehicles. Due to the dangers for sellers and merchants, this has caused price jumps and collapses, making it difficult in some situations for cryptocurrencies to be used for basic products and services.
Stablecoins can help with that. According to the notion, you can avoid price fluctuations by creating a currency that is “pegged,” or linked, to a standard fiat currency like the US dollar or another asset with a generally constant price.
Stablecoins are designed to make cryptocurrencies more secure and trustworthy while reducing the speculative nature of digital assets. They provide the steadiness of fiat currency with the security and decentralization of cryptocurrencies.
Different kinds of Stablecoins
1. Centralized Stablecoins
One of the original stablecoins and the most well-known is Tether (USDT). It asserts that it is supported by an actual cash reserve—referred to as “collateral”—that is “off-chain,” or in a physical place under the supervision of a centralized third party.
Investors can be confident that their tethers truly are worth one dollar apiece because this supply is securely stored in a bank’s vault, which helps to maintain the price stability. A staggering 48% of the total cryptocurrency trading volume is accounted for by stablecoin.
There is only one issue: Investors’ skepticism is fueled by the fact that Tether Ltd, the company that issues Tether tokens, has never definitively demonstrated that the currency actually has full backing. (More below on this.)
(EMOJI): Filecoin (oneFIL)
OneFIL was created by ICHI, a system for establishing “decentralized money authority,” 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.
Gemini Dollar (GUSD)/Paxos Dollar (PAX)/USDC:
These stablecoins were created by venture capitalists the Winklevoss twins, blockchain startup Paxos, and cryptocurrency exchange Coinbase (in collaboration with payment platform Circle), respectively.
They have all undergone stringent Wall Street audits and comply with regional regulatory frameworks. These tokens are growing in acceptance as people become less confident of Tether.
(EMOJI): Filecoin (OneFIL):
OneFIL was created by ICHI, a system for establishing “decentralized money authority,” 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.
2. Gold-backed Stablecoins
Although the vast majority of stablecoins are backed by US dollars kept in a bank vault, the development of stablecoins backed by other assets, such as various gold-backed cryptocurrencies, has been prompted by the general deterioration of opinion toward the USD and fiat in general. They all have investment-grade gold as a backing but range greatly in form and usability.
• CACHE gold (CACHE)within the most well-liked of them Each CACHE is backed by 1g of pure gold that is kept in global vaults. Although CACHE tokens can be quickly exchanged for actual gold at any time, sending them is the same as sending 1 gram of gold per token.
• There’s also Tether Gold (XAUt)and PAX Gold (PAXG), which operate in a similar way, but are instead pegged to one troy ounce of investment-grade gold. They also have a higher minimum redemption amount than CACHE.
3. AlgorithmicStablecoins
• Terra (LUNA) is a decentralized stablecoin, meaning it uses a sophisticated algorithm to maintain stability rather than relying on a reliable third party.
• Ampleforth (AMPL) uses a similar methodology. It uses a procedure known as a “rebase” to automatically alter the circulating supply of the cryptocurrency in reaction to changes in supply and demand rather than backing each AMPL physically with 1 USD.
The circulating supply will be increased or decreased in an effort to bring the price of AMPL back to $1 if it is more than 5% above or below the USD reference price.
Holders of AMPL always retain their proportionate share of the whole AMPL network because this rebase is proportional across all wallets.
• Dai (DAI) is said to distinguish itself from rival stablecoins by allowing for broad usage while remaining decentralized and trustless. DAI is an ERC20 token with a value tied to the US dollar that can be transferred between Ethereum wallets and was developed by blockchain startup MakerDAO.
Stablecoins are backed by a real cash reserve that is kept “off-chain” or in a physical location under the control of a centralized third party, such as Tether (USDT), Filecoin (OneFIL), Gemini Dollar (GUSD), Paxos Dollar (PAX), and USDC.
What are Stablecoins used for?
Because stablecoins are based on the blockchain, they provide holders with a variety of advantages. The first stablecoins were released as exchange-traded alternatives to fiat money, providing investors with shelter from the turbulence of other crypto assets.
Stablecoins can now be used in the decentralized finance (DeFi) sector to borrow money at rates that are higher than those provided by conventional savings accounts or to take out cryptocurrency-backed loans.
It is important to note that while stablecoin services may offer higher returns than normal savings products, they do not offer any government-backed protection.
Due to its ability to reduce the cost of transferring money across borders, stablecoins can also be used to pay salaries in cryptocurrency. On the blockchain, there is only a transaction fee that needs to be paid.
Also, cross-border transactions settle quicker on the blockchain and might take anything from a few seconds to an hour, depending on a variety of variables. These variables include the kind of network being utilized, any potential network congestion, the cost of fees, and the intricacy of the transaction.
Cross-border transactions, however, may not be settled by the conventional financial system for several days.
Stablecoins’ low volatility helped investors maintain their funds on the blockchain while lowering risk, in contrast to traditional cryptocurrencies that don’t have a fixed price and may swing wildly.
Stablecoins are exchange-traded alternatives to fiat money, providing investors with a shelter from volatility and lower risk.
How to keep Stablecoins stable
Controlling institutions like central banks maintain the stability of government-issued fiat currencies through the maintenance of their relative price stability.Stablecoins may be supported by government-issued fiat money, algorithms, or a tangible good like gold.
Stablecoins use the stability offered by governments and central banks to generate reserves in fiat currencies that are guaranteed by such governments, like the dollar.
To monetize stablecoin reserves and make sure they are appropriately supported and redeemable, a portion of them is invested in fixed-income instruments including short-term corporate debt and government-backed debt obligations.
To monetize stablecoin reserves and make sure they are appropriately supported and redeemable, a portion of them is invested in fixed-income instruments including short-term corporate debt and government-backed debt obligations.
The next sections will discuss the fundamental stabilizing processes used by stablecoins, including fiat backing, crypto backing, commodity backing, and algorithm backing.
• Stablecoins Supported by Fiat
Stablecoins with fiat currency backing keep their reserves in fiat money like the dollar. Fiat-backed stablecoins frequently have one dollar in reserve, either in cash or monetary equivalents, for each token that is in circulation.
In order to keep the entities holding stablecoin reserves compliant, central entities that manage stablecoin reserves regularly audit their financial holdings and collaborate with regulators.
Users must undergo Know Your Customer (KYC) and Anti-Money Laundering (AML) checks akin to those on exchanges in order to purchase stablecoins directly from issuers. Users’ personal data, including a copy of their official identification card, are collected during these processes.
Stablecoins can be sent and received by anybody once they are in circulation, albeit the central organization creating them may have the authority to freeze cash on addresses. In the past, stablecoins have been frozen as issuers, for example, worked with law authorities on investigations or tried to reclaim money that had been stolen.
• Stablecoins Supported Cryptocurrency
Stablecoins supported by other cryptocurrencies are known as cryptocurrency-backed stablecoins. Stablecoins backed by cryptocurrencies can be created to follow the value of the cryptocurrencies supporting them or the value of a fiat currency.
You can launch a single asset on a different blockchain by issuing a stablecoin backed by cryptocurrency. For instance, Wrapped Bitcoin (WBTC) is a stablecoin released on the Ethereum blockchain that is backed by Bitcoin.
Alternately, stablecoins backed by cryptocurrencies can track the value of a fiat currency through blockchain balancing mechanisms that depend on the stablecoins’ backing to maintain price stability.
In these situations, stablecoins are overcollateralized to make sure they can keep their peg even during times of extreme market volatility. When a stablecoin is overcollateralized, it indicates that the assets supporting it are worth more than the market value of the stablecoins.
To collateralize the $500 worth of a stablecoin backed by a cryptocurrency, for instance, $1,000 worth of Ether might be kept in reserve. The price of the stablecoin is more consistently stable thanks to frequent audits and monitoring technologies.
Stablecoins backed by cryptocurrencies can be generated through the use of automated smart contracts with no central authority regulating them, making them a more decentralized variant of fiat-backed stablecoins.
• Stablecoins Supported by Commodity
Stablecoins that are backed by reserves held by a centralized body are essentially commodity representations on the blockchain.
Commodity-backed stablecoins are backed by real estate, energy, and physical commodities like precious metals. Gold isthe most popular commodity used as collateral. It’s important to realize, though, that the prices of these commodities can and will change, potentially causing them to lose value.
It is made simpler to invest in assets that might otherwise be out of reach on a local level by stablecoins backed by commodities. For instance, it can be expensive and challenging to find a safe place to store gold bars. Owning physical assets like gold and silver as a result isn’t always a good idea.
Yet, people who desire to exchange tokens for cash or take ownership of the underlying tokenized asset can also benefit from commodity-backed stablecoins.
Stablecoins use the stability offered by governments and central banks to generate reserves in fiat currencies, which are invested in fixed-income instruments to ensure they are suitably backed and redeemable. To keep stablecoin reserves compliant, central entities audit their financial holdings and collaborate with regulators. Stablecoins can be sent and received by anybody, but the central organization may have the authority to freeze cash on addresses.
HybridS tablecoins
Algorithmic or hybrid stablecoins are stablecoins that use complicated algorithms to maintain price stability. These stablecoins work by balancing funds stored on the blockchain via smart contracts with supply and demand to preserve price stability.
The algorithmic stablecoins defend the market peg of their respective currencies as if they were actual central banks. When the stablecoin price exceeds the peg, assets are bought, and when the price falls below the peg, they are sold.
Because there isn’t enough over-collaterization, some algorithmic stablecoins are prone to lose their peg in the event of unexpected or black swan events. When the market price declines below the price of the fiat currency, an algorithmic stablecoin system will reduce the number of tokens in circulation.
Alternately, new tokens are created to lower the value of the stablecoin if the price of the token is higher than the value of the fiat currency it stands in for.
Algorithmic stablecoins balance funds with supply and demand to maintain price stability.
Non-collateralized or seigniorage-style stablecoins
While algorithmically-backed stablecoins have reserves in smart contracts, non-collateralized or seigniorage-style stablecoins do not. Instead, seigniorage-style stablecoins rely on intricate procedures designed to change the number of coins in circulation in accordance with supply and demand.
In order to keep their peg, non-collateralized or seigniorage-style stablecoins destroy and inflate the supply on-chain. These stablecoins are created without the use of collateral because they are self-collateralized. For instance, let’s assume the value of stablecoin A is $1.00.
Because there is more supply than demand for a stablecoin, the price has dropped to $0.70. Stablecoin A is purchased by the algorithm via seigniorage, which lowers the supply and returns the price to $1.00.
Seigniorage shares are issued if the price stays below $1 and there aren’t enough profits to buy more of the coin’s supply. This indicates that users are essentially making investments to increase the supply of uncollateralized stablecoins.
On the other hand, if a stablecoin’s cost exceeds $1.00, the algorithm creates more tokens, increasing the available supply until the cost drops below $1.00. Seigniorage is the term used to describe the earnings.
Conclusion
Stablecoins are digital assets designed to make cryptocurrencies more secure and trustworthy while reducing the speculative nature of digital assets. They are exchange-traded alternatives to fiat money, providing investors with a shelter from the turbulence of other crypto assets. Centralized Stablecoins are supported by an actual cash reserve.
