Stablecoins are a type of digital currencies that are non-volatile and are pegged to US dollars or to commodity like Gold. Their value remains stable, hence called stablecoins.
Stable coins have gained traction in the world of crypto as it solves two major problems: volatility and stability.
Importance of stablecoins
- Savior: For several crypto investors, stablecoins serve as an escape when they want to hedge out their cryptocurrency portfolio without cashing our to Fiat currencies. This proves to be especially effective in case of a bearish market or to keep the profit in Fiat value intact.
- Peer to peer loans: If the DeFi market grows, stablecoins will be essential as people would require a non-volatile means of transacting with each other, keeping the benefits of cryptocurrencies intact resulting in better usage of peer to peer loans.
- Global: The powers of Stablecoins are similar to Ethereum or any other cryptocurrencies, without the volatility. They are used globally and are easy to receive or send from anywhere around the world 24/7.
- High Demand: The demand for stablecoins is increasing constantly, thus lending stablecoins can earn the user interest, but make sure you are educated about the risks beforehand. Celsius, Blockfi, Nexo are some examples.
- Exchangeable: Stablecoins are exchangeable for ETH or any other crypto easily.
- Secure: They are secured by cryptography, preventing any forgery of transactions.
How do Stablecoins work?
The underlying entity behind stablecoin sets up a reserve where the asset is stored securely backing the stablecoin.
One million in traditional currency stored in a bank backs up one million units of stablecoin. This is exactly how the digital currency, stablecoin and the real-asset world are intertwined. The money in the reserve is the “collateral” set up for the stablecoin.
There are more stablecoins which are complex and are backed by other cryptocurrencies instead of fiat currency.
A third type of stablecoins, called the algorithmic stablecoin is not collateralized, the coins are either created or burnt to maintain the coin’s value in line with the target price or value. This type is less popular and used when compared to the other types.
Types of Stablecoin Collateral
Fiat-collateralized: Theses stablecoins are backed by fiat or traditional money. It follows a 1:1 ratio, where one unit of stablecoin is equivalent to one US Dollar. It is more stabilized because fiat currencies are backed by governments and there are lesser chances of drastic fluctuations. It is simple and easier to understand by the users. Theses stablecoins are centralized and go against the crypto narrative of decentralization, thus it is susceptible to higher risks and vulnerabilities such as single point of failure, bankruptcy of the central entity and moral hazards. They require external audits as it merely runs on trust and might require more regulations than the others as well. USDC and TrueUSD are a few examples.
Crypto-collateralized: Stablecoins almost has the best of both worlds, they are backed by crypto assets. Their price is dependent on the underlying asset or collateral which is volatile. Thus, stablecoins are overcollateralized to ensure the stability of its price, this leads us to a conclusion that one crypto-backed stablecoin is worth double the underlying crypto asset and the fluctuations of the underlying asset interrelated to the price of stablecoins. For example, Dai which is the most famous decentralized stablecoin.
Commodity-collateralized (Precious metals): Similar to fiat-based coins, these stablecoins use precious metals such as gold to maintain their value. Digix is an example.
Non-collateralized: (Also known as Seigniorage-style stablecoins) These stablecoins are not backed by any asset.It depends on the complicated sets of algorithms which purchase or sell stablecoins to maintain the stablity of price. Some examples are Ampleforth, Carbon and Kowala kUSD.
A new type of stablecoins were introduced recently called the Fractional algorithmic stablecoins or Hybrid stablecoins. These stablecoins are partially backed by stable algorithms and partially by collateralized assets.The prices of these stablecoins are determined by a flexible mix of collateral. FRAX is a popular example for this type.
Top 5 Stablecoins – Everything you need to know
Tether (or USDT) – Fiat collateralized
It is one of the oldest stablecoins which was launched in the year 2014 and is most popular till today. It is fiat backed stablecoin which converts real-life money to digital currency like the US Dollar, Euro and Chinese Yuan. Every tether token is pegged to 1-to-1 US$. The primary use of USDT is moving money quickly between exchanges and to take advantage of the opportunities when the prices differ on two different exchanges, profiting from the discrepancy.
Tether did get into trouble in the year 2018, they were hit with huge fraud allegations as the 1:1 ratio fell apart, one stablecoin was no more equivalent to 1 dollar, but 85 cents.. Tether’s ambitions landed them in trouble where the circulation of their tokens was increased suddenly, and the the USDT coins failed to maintain their equivalency to 1 US dollar each.
After overcoming this crisis, they are more transparent and publish the value of their reserves daily and have maintained their position at the top, it is the number one stable when ranked by market capitalization.
It can be traded on Binance, CoinSpot, BitFinex and Kraken. USDT is an ERC20 coin, primarily. It also exists in TRC20 and BEP20 form.
USD Coin (or USDC) – Fiat collateralized
USD Coin also works on the 1-to-1 pegged by the US dollar. It is solely backed by the US dollar, a fiat currency. USDC is a proven stablecoin, with regular audits which maintains the value of USDC to remain 1 dollar over any period of time.
USDC is powered by Ethereum, it is an ERC20 token so it can be stored in any Ethereum- compatible wallet, for example the Coinbase wallet. It can be utilized on any decentralized application (dApp) which is built on the Ehereum blockchain. This is what makes USDC popular in the DeFi community.
Recently,USDC partnered with the government of Venezuela, providing aid to healthcare workers and the people of Venezuela. Circle’s CEO and founder stated that stablecoins are now used as a tool for foreign policy in the United States of America, and USDC is leading the change as well as charge.
USDC is available to be traded on 7 different exchanges , a few of them are Coinbase, Poloniex, Binance and KuCoin.The advantage for Coinbase users is the simplicity of conversion from USDC to fiat money which can be withdrawn from traditional banks easily.
USDC might be going against the crypto narrative which is anti-fiat, but USDC chooses to take this opportunity to work in collaboration with real-life money which will make crypto mainstream in the coming future.
Dai – Crypto collateralized
It is a crypto-backed stablecoin which consistently tracks the US Dollar and can be viewed on the Ethereum blockchain publicly. It shifts while tracking market changes and hence maintains a steady price against other cryptocurrencies.
It is facilitated by the Maker platform with the MKR token, collateralised debt positions (CDP) smart contacts and other mechanisms of stabilization. Dai has been integrated with over 400 applications as well as services. It is more decentralised when compare to others because only the users have the authority to create or destroy the Dai tokens.
As it is issued on the MakerDAO platform, it is far more transparent than Tether as the operations are run and stabilized by smart contacts. Another advantage of using Dai is that Maker allows the users to choose the collateral they desire, a multi-collateral Dai.
Dai can be traded on HitBTC, Coinhub, Etfines, Gate.io, DDEX, OasisDex.
TrueUSD – Fiat collateralized
It is one of the most reliable stablecoins because of the organisation’s open strategy. TrustToken platform issues TUSDs which are based of assets held by regulated institutions like banks. TUSD ERC-20 token is considered the best stablecoin on Binance.
TrueUSD is secured by US dollars fully. It has around $1.44 billion in its reserves. TUSD is not featured as USDT on any platform,yet traders and investors prefer using TUSD becuase it is much more transparent about its working. Unlike USDT, which does not disclose its backing assets completely, TUSD is backed completely by the US Dollars.
It can be traded on Binance, Bittrex, OKEx, CoinEx, KuCoin
PAXOS Standard – Fiat collateralized & Commodity-collateralized (both are available)
It is the most trusted stablecoin by main, is extremely transparent and can be redeemed in USD for PAX. It also offers a token version of gold called PAXG which is fully regulated.
PAX has been approved by the New York State Department of Financial Services and has been registered under the New York State banking law. They can be stored in any ERC-20 supported wallet. PAX is considered as a safety stores by many users because 1 PAX is backed by exactly 1 dollar. When the coins are redeemed in USD, the PAX coins are destroyed.
It can be traded in Coinbase, Cex.io, Coinmama.
Users choose the stablecoin they desire by weighing the pros and cons of each stablecoin, it depends on their needs whether it is recognition, transparency, reliability or more.
What happened with USDC depegging
Just recently, something big happened in the world of cryptocurrency. The Silicon Valley Bank had a major disaster, and as a result, the USDC stablecoin lost its connection to the US dollar. Before all this mess, one USDC was worth exactly one dollar. But now, people started getting worried and spreading rumours about how the bank’s collapse could affect the stablecoin. As a result, the value of USDC dropped below a dollar. There’s this crypto tool called Nansen, and they said that Circle Internet Financial burned about $1.6 billion worth of USDC. This whole situation also had a big impact on the total value of the USDC market cap. It used to be around $43.5 billion, but now it’s down to $29 billion. When stablecoins like USDC move away from the currency they’re supposed to be connected to, people start worrying about whether they’re still financially stable. It’s a natural concern.
But since this is all pretty fresh news, it’s hard to say for sure if USDC will go down to zero like USDT did. We have our own thoughts on it, though. We think the chances of that happening are a bit lower because Circle is actively trying to figure out what to do after this whole mess caused by the SVB collapse. Now, just because about 8.2% of the money is stuck at SVB doesn’t mean that it’s all lost forever. Remember the FDIC recovery process we’ve seen in the past? Well, if that happens here, there’s a possibility that about 94% of the money will be paid out. So, the loss would be reduced to around $198 million. That’s still a lot, but it’s better than losing everything, right? Additionally, about 75% of the USDC assets are in a thing called Short-Dated US Treasury Portfolio. It means most of the money will be paid back in less than three years. So, even though there are these losses, the interest payments from these assets might help cover some of the money that’s gone missing.
Learn more about: USDC Depegging: Can USDC Go to zero like UST?
Frequently Asked Questions (FAQ)
Are stablecoins a good investment or a bad investment?
To be honest, Stablecoins are not for investment. They have their own purpose. But you can still think of Stablecoins to earn. Similar to any other investment, stablecoins as an investment has its advantages and disadvantages.
Reasons as to why stablecoins are a good investment:
- As stablecoins can be converted easily and quickly, they come as a handy investment to investors who have their eyes set on Bitcoin or any other volatile cryptocurrencies, as stablecoins are stable and provide a good start to investing in crypto. It can be converted back and forth whenever the confidence in the investment is varying.
- With low risks, stablecoins are worthy as well as beneficial to the user’s diversified portfolio. You can earn interest on your stable which are as high as 15 percent per year.
Reasons as to why stablecoins are a not so good investment:
- Even though the stablecoins might appreciate, there is a possibility they might depreciate instead. This might be applicable in the cases of crypto-backed stablecoins, despite these stablecoins having mechanisms in place, at the end of the day they are still backed by an inevitably volatile asset.
- Fiat-backed stablecoins might be the most stable tokens, but their value is unlikely to change over a period of time and thus might not behave a s a long-term investment. In this case, the value might decrease over time. Why? As the central bank mints more money, it devalues the currency. Inflation is another reason.
Overall, do not see stablecoins as an investment. See it as a way to save your portfolio on volatile days, without being needed to convert them into your FIAT currency.
What is better, USDC or USDT?
It depends on specific needs.
USDC are most often used in the United States and in countries where Coinbase is offered. Business entities use USDC to conduct their activities.
USDT is used by traders and investors. Why? Tether allows the users to protect their profits and maintain their investments in crypto by not subjecting themselves to the volatility of Bitcoin.
What are CBDCs? Are CBDCs stablecoins?
Central Bank Digital currencies are strictly fiat currencies produced by a central bank , simply put, they are digital forms of fiat and fiat is not stable. Hence, CBDCs are not stablecoins.
The difference between the two is that stablecoin is a creation of a private company, made with a synthetic derivative of fiat currency and CBDCs are digital fiat.
Stablecoins Vs other cryptocurrencies. Which is better?
Other Cryptocurrencies are extremely volatile when compared to stablecoins which are non-volatile. Most stablecoins are backed by assets, either pegged or collateralized and are hence more stable.
Public adoption is easier in case of stablecoin, which might pave a way for them to be mainstream in the near future.
Stablecoins have a purpose. For traders, it is a way to trade and convert their profits into. Stablecoins help them increase their portfolio in USD and equivalents.
For businesses raising money, they prefer stablecoins, as this gives them more flexibility. Raising funds from different investors take time, sometimes years. So if they take the money in non stable coins, the price may heavily fluctuate and they may lose a lot of money required to run their businesses, which they may not afford.
What is the future for stablecoins?
Bitcoin, Ethereum and other cryptocurrencies needs to be less volatile in order to be adopted by masses. But stablecoins have a better chance merely because of their stability, which can be trusted better. Stablecoins might seem like a road to a brighter future, a solution to financial problems that are modern but the future is not predictable easily. Stablecoins are a step closer to embracing digital currency, quite significantly, given their properties.