Stablecoin is a cryptocurrency that is pegged to another asset like USD or gold. The purpose of creating stablecoins was to avoid high volatility common in crypto assets.
Why are stablecoins important and what are they used for?
Unlike currencies like USD or Euro, stablecoins can be sent fast, cheaply, whenever, and wherever you are, just like bitcoin or other cryptocurrencies. That is a bridge between the blockchain field and banks. A stablecoin is often used to lock profits and keep the value as a stable asset. You can also earn interest on staking them, the interest rate is usually higher than those which banks offer. Moreover, many people just buy other cryptocurrencies using stablecoins.
The most popular stablecoins
As of June 2022, according to the coinmarketcap.com data, the most popular by market capitalization is Tether (USDT) with a market cap equal to $72 billion, the second one is USD Coin (USDC) worth $53 billion and then Binance USD - $17 billion. 2 months ago, we could also mention TerraUSD, but it lost its peg in May 2022.
Types of stablecoins
There are three types of stablecoin: crypto-backed, fiat-backed, and algorithmic. Crypto-backed keep their reserves in the other cryptocurrency as collateral. The second one is backed by FIAT currency like USD, and algorithmic does not use FIAT or cryptocurrency as collateral. FIAT currency refers to government-backed currencies that are not backed by gold or silver.
Cryptocurrency-backed stablecoins can be issued to track the price of other cryptocurrencies backing them. For example, Wrapped Bitcoin is a stablecoin backed by Bitcoin used on the Ethereum blockchain. However, there is also another example of crypto-backed stablecoin. The whole process of purchasing that kind of stablecoin takes place in the smart contract. Once you purchase it, you lock your cryptocurrency into a smart contract to obtain tokens of equal value. You can send your stablecoins back and receive the amount you deposited previously. The most popular crypto-backed stablecoin is DAI, based on the Ethereum blockchain.
These stablecoins are backed by real reserves of the FIAT currency with a 1:1 ratio, so each coin is backed by 1 dollar. Tether and Binance USD are examples of fiat-backed stablecoins. However, it does not have to be backed only by FIAT, it can include metals like gold or silver. These stablecoins offer complete stability compared to the volatility of other cryptocurrencies, however, they are centralized and require auditing to make sure that coins are fully collateralized.
They do not have any reserves. Instead of that, smart contracts and algorithms have control over the supply of stablecoin. They are visible on the blockchain for everyone. It is very difficult to create a successful algorithm, that is why there are not many of them on the market. TerraUSD is an example of an algorithmic stablecoin.
Advantages of stablecoins
- Fast, cheap day-to-day payment method. Stablecoins provide the same way of making transactions as Bitcoin or Ethereum have. Moreover, due to the peg, stablecoins might be more attractive to users, because of the 1:1 ratio to the dollar.
- Easy conversion to other cryptocurrencies, mainly used by investors and traders to secure their portfolios. You can both sell and buy Bitcoin etc. for stablecoins.
Disadvantages of stablecoins
- Stablecoins are more centralized than other cryptocurrencies. The supply of the coin may be increased by the central authority, moreover that entity may be subject to external financial regulations.
- They may not maintain a peg. Most of us heard about the TerraUSD failure, the coin lost its value from $1 to $0.008.
Almost every crypto investor has ever had a stablecoin in their portfolio. They use it for taking profits or storing value. The good thing is to have some stablecoins in the wallet because when the market crashes, you can just quickly buy the dip. Moreover, stablecoin is a great way to send payments or earn interest on staking to generate a passive income. However, some stablecoins failed, so make sure that you diversify your portfolio and do not invest more than you afford to lose.
Peg - a specific price that the token is aiming to stay at.
Fiat - a type of currency that is backed by the government, for example dollar, euro, pound.