Stablecoins are a type of cryptocurrency whose value depends on an outside asset. Examples of assets include the US dollar and gold.
These assets help stabilize the price and prevent the unpredictable fluctuation which comes with other cryptocurrencies. Stablecoin is a digital currency with no physical existence like fiat currencies.
Stablecoins are divided according to the basis of their working mechanisms:
These are the most common type of stablecoins. These depend on the value of any fiat currency like the US dollar or Euros.
They are usually backed at a 1:1 ratio, which means for every coin there is a fiat currency in a bank account.
For example, if the coin tether is collateralized at a 1:1 with the U.S dollar, 1 tether will equal 1 USD.
One argument against stable coin is that although they are easy to understand, they limit the potential of cryptocurrency and only act as substitutes for fiat currencies.
Crypto collateralized stablecoins
These are coins pegged to other cryptocurrencies and have an open-source code. It overcomes the fluctuations of the market with the help of a diversified reserve of cryptocurrency.
An example of this is DAI, a cryptocurrency that uses etherium as a platform to keep its value “pegged” to the dollar. They are often over-collateralized to withstand the instability of cryptocurrencies.
These coins depend on physical assets like Gold and real estate. Holders and investors hold a tangible that has value. These assets can also appreciate over time which encourages investors to use these coins. It helps average individuals to also invest as investing in an asset like gold is expensive.
One example of the coin is DGX (Digix Gold). 1 DGX equals 1 gram of gold. Itis stored in Singapore and audited every three months to ensure transparency. The investors can redeem the gold bars from the vault in Singapore.
SwissRealCoin (SRC) is backed by swiss real estate and has a max supply of 1 billion coins.
Why use stablecoin?
Like other cryptocurrencies, the stablecoin is not subjected to volatility. 30 dollars worth of bitcoins in 2010 are now worth millions of dollars and it made some businesses doubtful of using crypto as a valid means of payment.
Stablecoins are not like that. They make sure to tackle such volatility of the market and also prevent significant losses.
For instance, if bitcoin starts to lose its value, a holder can convert them to stablecoins within a matter of minutes.
They have proved to be thriving in quick and secure international payments. Firms and workers could benefit from stablecoin as it does not fluctuate in value like bitcoin or any other cryptocurrency.
It could be used in underbanked communities where economic uncertainty is a concern. It functions like a global currency and is not subject to local laws and conditions.
Its decentralized system help make the transactions more stable and secure. They also ensure reliable peer-to-peer transactions without the need for volatile cryptocurrencies such as bitcoin.
Drawbacks of stablecoin:
Fiat-backed coins are subject to the regulations of fiat currencies that may compromise their efficiency of conversion.
If economic crises occur, fiat-backed stablecoin will crash as they depend on currency.
Crypto-backed coins are subject to price instability given the violent fluctuations in cryptocurrency.
Commodity-backed coins can be hard to redeem if your investment is in a different country. You may have to go through a long process.
Future of stablecoin
Research shows that the supply of stablecoin has increased over the past few months. There is also speculation that stablecoins will make way for cryptocurrencies to be widely accepted. Stablecoins have growth potential, and with years to come, the stance would be clear.