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What are stablecoins?
What are stablecoins_
Cryptocurrency
15.09.2021
Updated 30.12.2021
7:00

Despite the obvious advantages of cryptocurrencies, they possess one parameter that scares off many users – the volatility (variability) of the rate. Due to this, it is not easy to use them to purchase goods and services. But to solve this problem, stablecoins were created, which will talk about in this article.

What is stablecoin? 

Stablecoin is a cryptocurrency created principally to eliminate the volatility factor of crypto assets.

Stablecoin is the cryptocurrency, the value of which is pegged to another type of asset in the ratio of 1:1 (as a rule, that is a dollar or other fiat currency, or a physical asset – gold, oil, precious metals, and minerals).

The emission of coins is regulated through collateral assets and takes place anytime when a sum that is identical by volume is deposited to special accounts in banks by project leaders.

Why are stablecoins used? 

The potential benefit from the use and distribution of stablecoins is only being estimated, but it is already possible to say with all confidence that this type of cryptocurrency allows to: 

That is only a part of the potential stable cryptocurrencies have. Stablecoins significantly expand the opportunities of the cryptocurrency field, smoothing over those disadvantages that are common to Bitcoin and other assets with high volatility. Thanks to their characteristics, stablecoins may become a basis for the worldwide adoption of cryptocurrencies.

Advantages of stablecoins for investors

Stablecoins bring a range of advantages for an investor. They:

  1. Allow investing in a cryptocurrency asset with a high level of predictability, liquidity, and price stability.
  2. Serve as a tool of risk management and allow to insure the portfolio from a threat of high volatility.

Disadvantages

However, one can face disadvantages when investing into stablecoins:

  1. They are excessively centralized, and the reputation and stability of a coin are significantly dependent on the decency and reliability of a company dealing with emission.
  2. The control of turnover and release of stablecoins cannot be done without an outside audit that specialized third parties, as well as banks, are engaged in.
  3. Stablecoins do not provide any cost-effectiveness. Investing in them simply fixes the volume of classical assets that the coin is pegged to. In the meantime, classical cryptocurrencies always give a chance for sharp enrichment.

Types of stablecoins 

The specifics of stablecoins’ work depends on what particular currency is being discussed. There are several types of cryptocurrency under consideration. Each type is bound to fiat funds in its way. We are not going to discuss all of them but will consider the work of some of them – the most popular ones.

Fiat-collateralized stablecoins

This type of stablecoins is pegged to the fiat currency in the ratio of 1:1. Such stablecoins have a central issuer (a bank may be in this role) storing some sum of reserve currency and releasing an equal number of tokens.

It works this way: an issuer has 10 thousand dollars; it releases an equal number of tokens so that one dollar ensures one token. If a user wants to exchange his token to dollars, this procedure may be done anytime.

This is where a weak point comes up since the users cannot know if the issuer has enough funds. Probably, there is not such an amount of money in its reserve. The only option a user has is to trust the issuer, and it should be as transparent regarding customers as possible. For example, it should publish the results of an audit. 

Currently, the market can offer only a few stablecoins backed by fiat funds. Particularly, we are talking about USDT (pegged to American dollars) and BGBP (pegged to British pound).

Stablecoins collateralized by precious metals 

Stablecoins pegged to the cost of precious metals (for example, gold, platinum, and so on) have a significant investment attractiveness: precious metals are assets with extremely low volatility, which tend to grow in price in the long run.

Stablecoins of this type are present in the market:

Crypto-collateralized stablecoins

This type of stablecoins follows the same principle as fiat-collateralized does. The only difference is that instead of fiat currency, cryptocurrency is used. When talking about the distinctions of these two formats, the fact of cryptocurrency ensuring namely is the point to go from.

In particular, tokens are bound through smart contracts precisely because cryptocurrencies are digital units, and there is a chance to implement zero trust approach.

The monetary policy also differs. Voters define it within the management system. In other words, there is no single issuer, but there are lots of participants of the network that will do everything possible to make sure their interests are met.

To get stablecoins, a user must lock some number of cryptocurrency within the contract. When there is a need, the system will give out the coins. The reverse exchange of the currency is done similarly. And of course, the cost will include interest rate and fees.

Various mechanisms of binding may be applied. What particular type will be used in the described case depends on the peculiarities of each separate system. As a rule, a simple combination of game theory and blockchain is applied.

Algorithmic stablecoins 

The type of stablecoins under consideration is connected neither to fiat nor cryptocurrencies, but an equally complex system ensures them – the combination of algorithms and smart contracts. It is them that create a scheme with a focus on which tokens are released.

The monetary policy of algorithmic stablecoins is similar to the policy of central banks towards national currencies. At least talking about the functional side of the issue. For example, if the token price falls lower than currency pegged to it does, the algorithm tracking this process will make adjustments right away. Particularly, it reduces the number of offered tokens in the market. And if the price rises, then additional tokens are added to the market instead.

These stablecoins are also called unsecured since they do not rest on material resources. But that is not so. There is really no material support, but this kind of cryptocurrency is ensured by collateral. So, the ‘black swan’ scenario is not a threat to it. Thanks to the collateral pool, this cryptocurrency system will be oriented on volatile market operations exclusively.

The most popular stablecoins 

To date, the most widespread types of stablecoins are secured ones. Among them, the following units stand out specifically:

The above types are the most popular, but it does not mean they are the only ones. Tokens backed by cryptocurrencies are introduced in the market more modestly. They include, for instance, Bitshares USD. Among algorithmic coins, it is possible to single out Basis. And that is not a full list at all. Currently, the market of stablecoins is actively expanding and developing, and the number of projects promoting their coins is only rising as well.

How can one receive stablecoins?

The simplest way to receive stablecoins now is to purchase them for fiat at a cryptocurrency exchange. To do this, you need to:

Conclusions

Stablecoins are one of the most promising types of cryptocurrencies. Surely, they have some disadvantages, but due to their relative stability, they may bring the system to a brand new level. Stablecoins unite the usual financial market and cryptocurrency mechanisms. Traders and investors have already paid attention to stablecoins by adding them to the portfolio.

FAQ

A stablecoin is a cryptocurrency whose value is pegged in a 1: 1 ratio to another type of asset (often a dollar or another fiat currency, or a physical asset – gold, oil, precious metals and minerals).

The easiest way to get stablecoins now is to buy them for fiat on a cryptocurrency exchange.