A Stablecoin is a cryptocurrency whose value is tethered to another asset, money, or financial instrument. This digital money is a substitute for volatile cryptocurrencies like Bitcoin.
Stablecoins effectively bridge the gap between cryptocurrencies and fiat currencies.
In terms of decentralized cross-border lending, these coins provide a safe online environment for P2P transactions without the need for volatile cryptocurrencies or the cost of currency translation.
The first Stablecoin: BitUSD
BitUSD, the first stablecoin, was issued on the BitShares network and released in 2014. Charles Hoskinson and Dan Larimer invented it. BitUSD was supported by BTS, the primary token of BitShares, and was collateralized by a number of other cryptocurrencies, each of which was locked in a smart contract in order to function as collateral.
Major types of stablecoins
Broadly speaking, there are four basic kinds of stablecoins:
Fiat-collateralized
The value of these stablecoins is backed by a pool of fiat currency. Gold, silver, and crude oil are other forms of collateral; nevertheless, the vast majority of fiat-collateralized stablecoins are backed by U.S. dollars.
Regular audits are conducted on the independent custodians who maintain these supplies.
Crypto-collateralized
Several cryptocurrencies back these stablecoins. Since the reserve cryptocurrency may experience high volatility, crypto-collateralized stablecoins are overcollateralized, which implies the value of cryptocurrency in supply exceeds the value of issued stablecoins.
Algorithmic
These stablecoins may both carry and not carry reserve assets. They maintain the value of stablecoins by controlling their supply using an algorithm, which is computer software that performs a predetermined calculation.
Commodity backed
They are backed up by transferable assets like precious metals. Gold is the most often used metal to back these stablecoins.
The underlying asset is often kept in the vault of a third party. The buyer might exchange the currency for a commodity.
How do stablecoins work?
A stablecoin, as a cryptocurrency, is built on well-known networks such as Ethereum. Although not under the supervision of the United States Federal Reserve, a stablecoin tied to the US dollar is affected by its actions. On that topic, if the Fed raises interest rates, it may boost the value of the dollar and stablecoins tied to it.
Consequently, as the value of the dollar declines, the value of stablecoins lowers as well. The management of reserve assets determines the value and dependability of a stablecoin.
Why makes stablecoins important?
There is little question that Bitcoin is the most popular cryptocurrency; nonetheless, its values are subject to significant fluctuation. Because volatility advantages traders, it makes normal transactions riskier for both buyers and sellers.
Moreover, merchants are unable to endure losses when the price of a cryptocurrency decreases and they are paid for it. Any currency that isn’t legal tender must be stable in order to assure that individuals who accept it will have purchasing power in the near run.
Stablecoins address such difficulties by stabilizing the cryptocurrency’s value in a variety of methods.
Most popular stablecoins
Stablecoins that are popular include:
Tether
Tether (USDT), one of the first stablecoins, was launched in 2014 and has been popular ever since. It is a very valued cryptocurrency in terms of market capitalization.
Binance USD (BUSD)
BUSD is the third most valuable stablecoin in terms of market capitalization. It is not only directly tied to the dollar, but it is also backed by an equal quantity of US dollars and government notes.
USD coin
Circle and Coinbase launched the stablecoin via the Centre Consortium in 2018. The USD coin is tied to the US dollar before being converted into a mix of collateral assets.
TrueUSD (TUSD)
TUSD, the fifth biggest stablecoin by market size, is the first regulated stablecoin backed by the US dollar, according to TrustToken, its parent business.
Dai
It was founded in 2015 and is built on the Ethereum blockchain, using the MakerDAO protocol. Dai is a decentralized currency that is tied to the US dollar.
Common stablecoin collaterals
Stablecoins are supported by a variety of assets, including:
Fiat
The most common kind of collateral is fiat, with the US dollar being the most common. Companies, on the other hand, are anticipating a variety of alternative currencies.
Cryptocurrencies
Certain stablecoins utilize other cryptos with Ether being one of them.
Precious metals
There are a few stablecoins with values tied to the value of expensive metals like gold and silver.
Investments
USDT was first intended to be directly backed by dollars, yet its collateral composition varied over time. In 2021, the company revealed that about half of its reserves are in commercial paper.
Uses of stablecoins
Stablecoins can be used for a number of purposes and some of which are as follows:
Volatility
Bitcoin and Ethereum are two cryptocurrencies whose prices vary like everything else. Stablecoins, on the other hand, is tied to a stable and reliable currency, allowing buyers and sellers to feel certain that their values will not abruptly grow or decline.
Easy transfer
Stablecoins do not need a bank account to be held and may be readily transferred. Not only can the value of stablecoins be transmitted easily over the globe, but they may also be used in regions where the US dollar is difficult to get or when the local currency is unstable.
Recognition
Prominent banking organizations see stablecoins as a trustworthy option for international payments. Stablecoins are a wonderful alternative for sending payments anywhere in the world since they are processed swiftly and have a minimal transaction cost.
Risks of stablecoins
Even though they look risk-free, stablecoins do have certain risks. Take a look at some of them:
Safety
Stablecoins, like other cryptocurrencies, must be held someplace, whether in a digital wallet, an exchange, or with a broker. This raises the possibility of dangers, since the specific trading platform may have weaknesses and security flaws.
Reserve risk
Reserves are an important part of the stablecoin ecosystem. These reserves serve as the value of a stablecoin’s support mechanism. Having said that, the coin issuer cannot calculate a stablecoin value without them.
Lack of confidence
A stablecoin that is not backed by tangible assets risks losing its peg to its target currency. This is what happened to TerraUSD in May 2022, since it was not backed by cash. Its value dropped as traders lost faith in it.
What does the future look like?
A stablecoin is managed algorithmically rather than by a centralized entity. Additionally, its advantages are similar to those of fiat currencies. Its stability may pave the way for the routine adoption of digital assets. Nevertheless, in light of the difficulties, other kinds of regulation are being investigated.
Stablecoins have the ability to completely change the payment system. They will revolutionize the way digital assets are utilized in the financial industry by continually stabilizing and gaining the confidence of the public. But, since they have a dangerous side, how they will impact the future of finance is best left to chance. Overall, investing in stablecoins is a game of carefully assessing the advantages and downsides.
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