A Beginner’s Guide to Stablecoins
Stablecoins are a class of cryptocurrencies that attempt to offer price stability to its investors. They are backed by algorithms or substantial assets that adjust their supply, based on demand.
In 2014, the first stablecoin was issued and since then, they have grown and gained popularity. Considering their efficiency, stablecoins offer speed and security within the blockchain; while ensuring less volatility experienced by other cryptocurrencies. With stablecoins, crypto traders can buy and sell cryptocurrencies on applicable trading platforms.
Stablecoins like USDT (Tether) are common on several cryptocurrency exchanges and trading platforms that don’t offer fiat currency trading pairs. Tether is known to provide liquidity for traders, and if you have followed our articles thus far, you should be acquainted with it by now.
In summary, stablecoins are blockchain-based versions of a country’s fiat currencies. Let’s get some more information!
What are Stablecoins?
As mentioned earlier, stablecoins are a specific type of cryptocurrency that are built to ensure stability within the blockchain. They also ensure stability among other cryptos due to their backing; which originates from assets like gold or the US dollar. Unlike stablecoins like Tether (USDT), other cryptocurrencies like BTC are not pegged to a stable asset.
You can say that their value comes from several peer-to-peer technologies and software-oriented Cryptography. Most of the time, stablecoins provide leverage for traders whenever they plan on adding new cryptocurrencies to their portfolios. The more people keep adopting them, the more other cryptocurrency exchange platforms can keep using them.
In summary, stablecoins are programmable; since they are blockchain-based versions of an actual fiat currency. They also interact with blockchain-based applications and smart contracts; which is why they are suitable for lending platforms and payment options. Let’s see the different types of stablecoins that are available to traders.
Types of Stablecoins
There are various sources backing your popular fiat currencies, including a country’s fiat currency, among other sources. However, traders and whales know that its backing source could impact its fungibility and risk level. Using fiat-based cryptocurrency tokens as an example, we notice that they can be more stable due to their link to a more centralized network or financial system. This centralized platform has more authority over the actions of the currency than its users.
‘Fiat-collateralized stablecoin’ is the most appropriate definition of a stablecoin. Since stablecoins are designed and issued with respect to a fixed ratio that is subject to the fiat currency, they have several sources of backing. They can be backed by fellow cryptocurrencies and precious metals. Under this type of stablecoin, the amount of issued tokens is subject to a 1:1 volume, with the total cash amount in a vault or bank.
Stable coins that are backed by a fiat currency, like the U.S. dollar will always maintain their reserves in fiat currencies. So, as mentioned earlier, for every token in circulation, the fiat-backed stablecoins will have one dollar in its reserve; either in cash or its equivalent.
For example, a stablecoin that has a value of one; 1 USDT is equal to the exact value of $1 in fiat currency.
So, if a cryptocurrency exchange is issuing 1 stable coin, $1 will be deposited and kept at a bank or any other central custodian. For stablecoins to be traded by users and from issuers, traders would need to perform Know Your Customer (KYC) and Anti-Money Laundering (AML) checks provided by the exchange platform. The exchange requires user information like identification, facial recognition and sometimes proof of address.
Once users have completed the above requirements, the cryptocurrency will be available for circulation. However, you should note that the central entity issuing them will have due authority to freeze and possibly clear the funds that each specified address holds. This action isn’t new, as stablecoins have been frozen many times in the past by law enforcement agencies during investigations.
It’s also important to know and understand the cryptocurrency behind cryptocurrency-backed stablecoins. Certain stablecoins are backed by volatile assets; hence, they are overcollateralized to ensure that their value remains stable.
Here’s an example, if there’s a stable token worth $2, having a $5 asset, a trader should understand that if its underlying worth loses value, the stablecoin has a bounce-back mechanism that allows it to remain stable.
Crypto-backed stablecoins are great cryptocurrencies for pair trading; however, they have certain disadvantages. These disadvantages include their volatility, compared to other fiat-collateralized cryptocurrencies. Also, stablecoins can easily and suddenly be destroyed; irrespective of the disadvantage, knowing which stablecoin to use is very important for every trader.
There have been several arguments in past years about the fate of stability and privacy in the crypto space. One of these arguments was made by F.A. Hayek, in the early 70s -his argument was that a privately used, non-collateralized and stable price coin would definitely change the dominance of all fiat currencies.
To keep the price stability of any stable currency, Robert Sam came up with the Seigniorage Shares scheme which introduced the use of smart contracts. These smart contracts work on a certain monetary policy and ensure that an issued currency remains tradable at $1.
Non-collateralized stablecoins are somewhat ambitious. However, there are several unanswered questions that they present. Some of the questions revolve around the downward pressure that would affect the system, the probability of whales buying or selling when the system declines, and so on.
Best Stablecoins According to Market Capitalization
Tether or USDT is one of the most popular stable tokens ever created on the blockchain. It runs across several blockchain networks, including Tron, Ethereum, Binance Smart Chain, and others. USDT can be traded with several pairs- it has one of the largest pair trading bases. It is also backed by an overcollateralized and secure network.
BUSD is Binance’s own stablecoin which was developed when Binance partnered with paxos.
USDC is BUSD’s rival and coinbase’s unofficial stable token. It was built by Circle; a payment company with roots in Goldman Sachs- it was or is meant to be an institutional-grade digital currency, having a large regulated infrastructure and fiat reserve. In its exsitence, USDC has had over $750 Billion transfers between Solana, Ethereum, and Algorand.
Compared to other stable coins, DAI is a mintable and decentralized cryptocurrency. As mentioned earlier, it is a decentralized stablecoin issued by the Maker DAO protocol and designed on the Ethereum blockchain. DAI is minted by depositing ETH in Maker DAO’s reserve vault and it is pegged to the US dollar. So far, it has kept its price pegged, making it one of the most liquid stablecoins.
Unlike BUSD and DAI, Diem is a global range digital currency that was developed by Meta (originally Facebook). Diem was designed to compete with central bank digital currencies (CBDC) and hence, utilizes a blockchain-based payment system.
Where Can I Buy Stablecoins?
Buying stable coins is very easy, especially with newer and faster exchange platforms like Binance, KuCoin, and OKEx. Although some stablecoins are not available in all locations, you are likely to find others in the specified exchange. You can try buying through P2P options or carded payments- you can buy through your credit or debit card.
The Importance of Stablecoins
- Stablecoins provide larger access to global financial systems since most people or individuals using the internet and cryptocurrencies have access to stablecoins.
- They are programmable and provide an option for developers to update their source code.
- They cannot be affected by other cryptocurrency volatility.
- Stablecoins cause a rise in the number of blockchain development companies, due to the alignment of fiat and digital platforms.