To provide an alternative to the problem of high volatility in the crypto market, the digital currency stablecoins was introduced. They are useful as a medium of exchange as they maintain their stability by pegging or tying their market value to an external reference or asset class such as traditional currency or gold.
They gained traction after the release of the first coin, BitUSD, in 2014, which was issued as a token on the BitShare blockchain. The reason for this traction includes
This unique ability provides a multitude of possibilities and has made them participate in the ongoing digital transformation, especially concerning the rise of non-fungible tokens (NFTs) and metaverse.
What Are They Used For
Traditional currencies are considered risky by mainstream users because of their long-term and short-term stability, so cryptocurrencies were adopted for a digital transformation to replace fiat money. They are not affected by the volatility or instability of the crypto prices and offer a list of benefits.
The value of cryptocurrencies, like Bitcoin and Ethereum, faces a lot of market fluctuations. Stable coins are assets that are pegged to a state currency, so they provide the buyers and traders with the surety and security that the value of their token will not rise or crash unpredictably in the future.
They offer easy ways to earn a reward on a stablecoin investment. The rewards are typically higher than those awarded by traditional banks.
Cheap Transfer Of Money
It allows cheaper money transfers than traditional banks, with fast processing and low fees for transactions being charged throughout the world and internationally. Financial institutions like JP Morgan and Wells Fargo consider stable coins to be an efficient solution for settling international payments.
Trade Or Save Asset
They are easy to transfer without the need for a bank account throughout the world, even in areas where the local currency is not stable or where the U.S. dollar may be hard to obtain. They are also considered a perfect currency for the trade of NFTs.
How They Remain Stable
Since the fiat money is issued by the government, it remains stable throughout because of the actions of controlling authorities like central banks. They make sure the prices of their currencies remain relatively stable.
Since the stablecoin is backed by a physical asset such as gold, by algorithms, and by fiat money by the government.
They take advantage of the stability that is provided by the government and central banks to create their reserves in the government-backed traditional currency such as the U.S. dollar and remain stable by using a few processes like backing the Fiat, commodity backing, crypto backing, and algorithm backing.
Frequently Asked Questions
What Are The Types Of Stablecoin Collateral?
A variety of types of assets are used as backing in the collateralized stablecoins.
This is the most common type of collateral where the U.S. Dollar is the most popular among all the other currencies. Some companies are also exploring coins that are pegged to other fiat money, such as BiLira, which is pegged to Turkish Lira.
Some coins also use cryptocurrencies as collateral, such as Ether, which is a native token of the Ethereum network is an example of it.
Apart from conventional and cryptocurrency, some are also pegged or tied with metals such as silver or gold as collateral.
What Are The Most Popular Stablecoins?
They are divided into four main categories, which we will discuss here.
Fiat-Collateralized Stable Coin
Maintaining a ratio of 1:1, these are the most common and popular types. This ratio means that one coin can be exchanged with one unit of the currency. They are backed or collateralized by digital currency like GBP, USD, or EUR.
It is the simplest but most centralized category where a central entity acts as a reserve custodian to manage the issuance and receipts.
Non-Collateralized Stable Coin
The price stability of a token pegged to an asset in this category is maintained by using seigniorage-style algorithmic stablecoins that are non-collateralized. Thus, they rely on algorithm-generated smart contracts for the sale and supply of tokens.
Crypto-Backed Stable Coin
Cryptocurrencies are also used to back these coins and can be issued to track the price of the cryptocurrencies through balancing mechanisms on the blockchain. Such coins are issued for launching one asset on a different blockchain, i.e., Wrapped Bitcoin (WBTC), which is a stablecoin that is backed by Bitcoin and is issued on the Ethereum blockchain.
They can be created by using automated smart contracts without a central entity controlling them. This way, they behave as a decentralized version of reserve-backed.
Commodity Backed Stable Coin
These are the blockchain-based representations of commodities that are backed by reserves held by a central entity. It uses physical assets such as precious metals, real estate, and oil to back.
These commodities tend to fluctuate in price and can potentially lose value. Also, owning a tangible asset is not always a viable option, especially when you don’t have a secure storage site.