Stable, what an ironically scarce word in the crypto space. Seeing as the majority of cryptocurrencies have the reputation of being the complete opposite of stable, one must question where stablecoins came from and why they are here.
This article will cover:
- What is a stablecoin?
- Types of stablecoins & how they work
- How do stablecoins work?
- Why do we need stablecoins?
- Different types of stablecoins
What is a Stablecoin?
A stablecoin is a type of digital asset that is pegged to a real-world asset or fiat currency. As a result, it is not volatile like other cryptocurrencies like Bitcoin (BTC) and Ethereum (ETH). With 4000+ cryptocurrencies in existence in 2021, the majority of them are not stable. This means they can fluctuate based on their market capitalisation, how many coins are in circulation, or how many people are investing and more. Stablecoins arose when there was a need for some stability in the market. They still run on the same blockchain technology just like other cryptocurrencies, but they have been set up for the value to not waver so much.
Types of Stablecoins and How They Work
There are a few ways that stablecoins can maintain price stability. Here are some examples of different types of stablecoins and how they work.
Pegged to Fiat currency or commodity assets
Some stablecoins are pegged to a real-world asset such as the US dollar or precious metals. When the coin is pegged, the value is simply based on whatever the value of that outside asset is. These assets like the US dollar still fluctuate, however at an extremely slow rate that is much more common in traditional finance.
USD Tether known as USDT is a very common fiat-backed stablecoin that is backed by the US dollar. USDT is issued by a Hong Kong based company called Tether. Tether is said to have a reserve of real USD equivalent to the amount of USDT they provide to their users.
Pegged to Crypto Stablecoins
When the stablecoin is pegged to another cryptocurrency, that particular crypto becomes its collateral and will have coins locked up to ensure it can be pegged. When being pegged to another crypto the ratio is never 1:1 as the price can still be so volatile. The higher ratio compensates for the price increasing and decreasing so drastically. Although it will maintain price stability, the coin can still sway like other currencies on the blockchain.
DAI is one of the most common crypto-backed stablecoins. It represents a 1:1 ratio with the US dollar, however, instead of the dollar being the collateral, users must lock up their ETH in the form of pooled ether as collateral instead. The stablecoin operators are the network of people using DAI.
This type of stablecoin does not rely on fiat or crypto as collateral. It simply has a smart contract set up that adjusts its market cap based on price fluctuations. If the price falls it will automatically reduce the total supply so the price goes up again. If the price increases too much it will automatically add more tokens into circulation for the price to come back down. These types of stablecoins are commonly used in DeFi projects.
Ampleforth (APL) is a cryptocurrency and financial building block. It used ‘rebases’ to adjust the supply in correspondence with the size of the network. Users tokens will go up and down however the price of the tokens will remain the same.
Why Do We Need Stablecoins?
Volatile Prices Limit Cryptocurrencies Uses
Price volatility in the crypto market is what got crypto the attention it has today, some people even love the dramatic price changes when it comes to investing. The price can move so quickly and aggressively, especially in comparison to the traditional stock exchange, and when it’s a bull market that can be exhilarating. However, when all the coins are like this it limits the use cases for the full potential of cryptocurrency.
Better for Making Payments
Stablecoins are also a more efficient way if you are looking to make a payment using cryptocurrency. When paying using another cryptocurrency it can get complicated as the price changes from one hour to the next. If you think about the guy who purchased 2 pizzas for 10,000 BTC in 2010, you can see why this might be a flawed system for payments.
Easier to Exchange than Fiat
Stablecoins are on many exchanges for trading as they are a safe store of value, while still having easy access. For example, if you have bitcoin and the price goes up and you want to take some of your profit out, you can exchange it to a stable coin so that it is still in your wallet but the value does not change. You can then invest it back into bitcoin or another cryptocurrency whenever you like instead of exchanging more fiat which usually has a higher rate.
How Can I Get Stablecoins?
Stablecoins are on almost all exchanges as it makes their customer experience much easier and keeps the fees lower than always exchanging to fiat. Although a lot of them are pegged to the US dollar, they are still found on global exchanges and can be purchased with national currencies. For instance, you can buy a range of stablecoins like USDT, USDC, BUSD, and TUSD on the Swyftx exchange.
Stablecoins are a type of cryptocurrency or digital asset whose value is not as volatile as other coins like Bitcoin or Etherereum. They can fluctuate based on things like market capitalization, how many coins are in circulation, or how many people are investing. Some stablecoins are pegged to a fiat currency or a real-world asset such as the US Dollar or precious metals. Although the pegging helps to maintain price stability, the coin can still fluctuate like other currencies on the blockchain.
Stablecoins have a smart contract set up that adjusts its market cap based on price fluctuations. If the price falls, it will automatically reduce the total supply so the price goes up again. These types of stablecoins are commonly used in DeFi projects. They are a safe bet to hold value, while still having easy access to the market.
So if you’re expecting a market downturn, and want to keep your money in crypto without converting it back to AUD or USD, you could consider a stable coin.