If you invest in cryptocurrency or have ever invested, you must have come across the term ‘stablecoin.’ Stablecoins are cryptocurrencies whose value is tied/pegged to a FIAT, such as the US dollar or Euro. They act as a bridge between crypto assets and government-backed currencies, allowing investors to invest in different cryptocurrencies seamlessly. A stablecoin brings stability in a highly volatile crypto market, allowing investors to park their funds securely in a turbulent market condition. The total market cap of such tokens is around $150.68 billion, which is nearly 15% of the total crypto market cap.
What Is The Point Of A Stablecoin?
A stablecoin is an answer to the majority of problems associated with the high volatility of the crypto market. When we talk about crypto, with stablecoin, we mean cryptocurrencies pegged to the US dollar. USDT, USDC, and BUSD are some examples. While stable assets may sound like an oxymoron in a market like crypto, they were designed to bring predictability, minimizing the risk for investors.
When the market enters a choppy phase, investors can exit active trades and convert their crypto assets into a stablecoin, safeguarding their funds. As more and more investors jump on the bandwagon, the importance of stable assets will continue to increase. Also, as the crypto economy flourishes and the industry employs more and more professionals located in different countries, stable tokens can be used as a standard currency to pay salaries. Going forward, their use cases are likely to skyrocket.
How Do Stablecoins Work?
Stablecoins work like any other cryptocurrency, except that they are pegged to the US dollar and have stability. They are built on the blockchain to provide stability to exchanges. Users can store stable tokens in exchanges or hardware wallets just like any other cryptocurrency. Such assets are also linked to a reserve of external assets, and this is what provides them stability. To sum up, stablecoins are a new subset of cryptocurrency.
What Are The Different Types Of Stablecoins
There are four different types of stablecoins, and each one of them has a different fixing value. Here are the different types of stable assets:
- Fiat-backed: Fiat-backed stablecoins are the most popular ones. USDC is an example of a fiat-backed stablecoin. USDC is pegged to the US dollar to 1:1 ratio, making it convenient for investors to convert real-world money into a crypto asset without any loss of value. Fiat-backed stablecoins are also known as traditional collaterals. Since the collateral is not any other cryptocurrency, fiat-backed stablecoins are considered off-chain assets.
- On-Chain Stablecoins: As the name suggests, on-chain stablecoins are backed by other cryptocurrencies. So on-chain stable assets are pegged to the value of another, more established cryptocurrency. $DAI is the most popular on-chain stablecoin. Users have to lock their cryptocurrency into a smart contract to obtain on-chain stablecoin tokens of equivalent value. When required, users can put the stablecoins back into the smart contract to withdraw their original collateral amount. Unlike fiat-backed stablecoins, on-chain ones are over-collateralized to maintain stability.
- Algorithmic Stablecoins: Unlike the above two stablecoins, algorithmic stablecoins are not backed by real-world commodities. Instead, they use special algorithms and smart contracts to maintain supply and stability. The token supply of algorithmic stablecoins reduces if the market price falls below the price of the fiat currency it tracks. Similarly, if the market price goes above the fiat currency it tracks, the circulation decreases to bring back the price for stability.
- Commodity-backed Assets: Commodity-backed stablecoins are pegged to physical commodities or assets like gold, oil, real estate, or other precious assets. Paxos Gold (PAXG) and Tether Gold (XAUT) are the two most popular commodity-backed stable assets. However, the value of these commodities can fluctuate too. Therefore, the stability of commodity-backed stable assets is not always guaranteed. The primary task of such coins is to facilitate investment in traditional assets and make them more accessible. As tokenization of real-world assets like real estate picks up pace, the importance of commodity-backed stablecoins is only going to increase.
Major Cons Of Stablecoins
- Centralization: As said earlier, stablecoins contradict the principle idea behind crypto, i.e., decentralization. They do have a certain degree of centralization since they are controlled by an exchange or a company. Also, their value depends on the stability of the asset they are pegged to.
- Lack Of Transparency: Stablecoins often receive criticism for lack of transparency. Tokens like USDT have been at the receiving end several times over the incorrect amount of reserves and fines and regulations imposed by the government. Stable assets definitely need to be more transparent regarding their operations.
Takeaway
In the end, it all boils down to picking the right stablecoin. As the crypto community broadens with more than 16,000 tokens in circulation, there are a number of stablecoins available to users. Fiat-based ones are the most popular and available across exchanges since they are pegged to the world’s strongest government-backed currency, i.e., $US. The majority of investors use fiat-based stablecoins. However, if you want to invest in traditional asset classes like gold or real estate, you can opt for commodity-backed stable assets.
They continue to help millions of investors with risk management and portfolio management. It acts as a safe house for your digital assets, especially in a choppy market. Going forward, the importance of stablecoins is only going to increase.