When it comes to investing in cryptocurrency, there is a multitude of projects and coins to consider, each serving their own individual purpose and use case. Stablecoins play an essential role and have many use cases throughout the crypto space.
What Is a Stablecoin?
A stablecoin is a type of cryptocurrency which derives its value from the currency or commodity it is tied or ‘pegged‘ to. Unlike Bitcoin (BTC) or Ethereum (ETH), stablecoins offer an alternative to highly volatile digital currencies.
What Are The Different Types of Stablecoin?
Fiat Collateralized Stablecoins
The term ’fiat collateralized stablecoin’ refers to the reserve, in this case, fiat currency such as the U.S. dollar, used as collateral to assure and maintain the stablecoin‘s value. Precious metals such as Gold, Silver alongside other commodities, can also be used as collateral, although most fiat collateralized stables have the U.S. dollar as the reserve asset. Popular stablecoins such as Tether (USDT) and True USD (TUSD) are backed by the U.S. dollar.
Crypto Collateralized Stablecoins
Crypto collaterlized stablecoins have their value collateralized by other digital assets. Using volatile cryptocurrencies as a reserve to prevent price fluctuations may seem odd. However, it hasn’t stopped some projects from using it in combination with governance and other commodities to hold the price of the stablecoin.
Algorithmic stablecoins don’t necessarily have to be tied to any reserve assets to maintain their value. The primary difference is that the value is stabilized by the supply being controlled through an algorithm.
This doesn’t differ too heavily from central banks, take the federal reserve, for example; they also don’t rely on any reserve assets. However, they have the advantage of being an issuer of legal tender, a luxury the crypto ecosystem cannot boast of. Many investors have expressed concerns around algorithmic stablecoins, even more so following the demise of Luna’s UST coin, which plummeted in price once it lost its peg to the dollar.
How can you use stablecoins?
If you invest in various crypto assets using multiple crypto exchanges, stablecoins can be utilized to keep your funds on the blockchain when exiting more frequent short-term trades. They can be used for cashing out longer time frame investments as well. However, regular traders see more benefits as you avoid the exchange’s withdrawal fees. This comes in handy when there are significant moves in the cryptocurrency markets; investors often use stables as a store of value to protect their investments.
If you plan on using stablecoins, check for significant liquidity on the exchange you’re using. Liquidity shouldn’t be an issue when using comprehensive exchanges such as Binance and Coinbase. Lack of liquidity can be problematic if you use stables for Defi transactions. If you want reassurance, research the trading volume of the stablecoin you use for each trading platform.
Stablecoins with a larger market capitalization typically have higher trading volume, although this will vary depending on the exchange. Exchanges often issue their own stablecoin; for example, Binance has Binance USD (BUSD). Other top stablecoins in terms of market cap are USDT (Tether), USDC (USD Coin), and DAI.
With the rapid growth of blockchain technology, Stablecoins continue to come under scrutiny by regulators. This is not surprising given their potential to affect the more traditional financial system. Over the last few years, there have been increasing calls for stablecoin issuers to conduct full and regular audits. This would highlight some of the risks with stablecoins and provide insight into how price stability is managed.
Tether is an issuer that has come under regular fire and has recently paid $18.5 million to New York attorney general Letitia Jones after they accused the company of a cover-up over considerable losses. Aside from the U.S. dollar, Tether is backed heavily by commercial paper, which again has led people to question the company’s financial stability.
It‘s no secret that a regulatory framework for stablecoins would legitimize their role across the crypto markets and make them more trusted by financial institutions.
As a whole, stablecoins offer the benefits of blockchain technology alongside the stability of fiat currency. Many blockchain advocates see smart contracts as the future of stablecoins, as businesses may look to incorporate them for making payments and alleviate any need for a centralized third party.
Companies such as Circle are trying to achieve precisely this. For traditional businesses to take advantage of cryptocurrency, they will require a transition into a blockchain infrastructure. Stablecoins offer the perfect bridge into the crypto ecosystem without price volatility risk.