Friday, September 30, 2022

What is a Stablecoin?

The rise of Bitcoin (BTC), and its underlying technologies in recent years has posed a significant change to our traditional banking structure. This change poses a threat as cryptocurrency investors have seen their fortunes drop in response to the volatilities of these digital assets.

Mitigating these excessive fluctuations and losses they bring is where stablecoin comes in. To put it simply, stablecoins are designed to exhibit more stability in their attached value than other cryptocurrencies. 

Stablecoins were established to combine the advantages of fiat currencies with the security of the cryptocurrency market in order to optimize both benefits. Securing anonymity and flexibility while facilitating crypto-related transactions.

Stablecoins, unlike cryptocurrencies like Bitcoin, have a fixed value that cannot be adjusted. Because they are backed by assets such as fiat money, they have become increasingly popular. Stablecoins are being designed to be pegged with a wide range of fiat currencies including USD, EURO, and YEN amongst others.

The mechanism behind stablecoins 

Stablecoins were first launched in 2014, making them a relatively recent addition to the cryptocurrency landscape. Despite this, their popularity and use have skyrocketed in recent years. 

As time progressed and other cryptocurrencies gained in popularity, stablecoins were used as a trading pair to purchase them instead. Many bitcoin exchanges were unable to operate since traditional financial services were not readily available at the time. 

Stablecoins, which are digital currencies based on blockchain technology, are distinguished by their collateral structures, which include fiat, cryptocurrency, commodity-backed, and a monetary base for stablecoins. It doesn’t matter if stablecoins have different underlying collateral structures; they all aim to achieve long-term stability. Stablecoins can be broadly classified into four main categories. 

Types of stablecoin

Traditional Collateral (Off-Chain)

Stablecoins backed by fiat currency are the most popular. An off-chain stablecoin is one that does not use another cryptocurrency as its underlying collateral. Collateral is held by a central issuer or financial institution and must be equivalent to the number of stablecoin tokens in circulation. 

Crypto Collateral (On-Chain)

As with any stablecoin, the value of one cryptocurrency is used to back up the value of another. This is known as crypto-collateralization. Rather than relying on a single fiat issuer, this method is completely decentralized and takes place exclusively within the blockchain network itself.

DAI is the most widely used stablecoin in this category, and it is also the most widely used stablecoin overall. This is accomplished through the use of MakerDAO’s collateralized debt position (CDP), which secures assets on the blockchain in the form of collateral. 

Algorithmic Stablecoins

Algorithm-based stablecoins do not require any sort of collateral, such as money or cryptocurrency. As an alternative to the previous types, the supply of tokens in circulation is managed using specialized algorithms and smart contracts. 

Commodity-Backed Stablecoins

In order to maintain its value, this type of stablecoin is backed by tangible commodities such as precious metals and real estate. When it comes to collateralized commodities, gold is the most commonly used. Tether Gold (XAUT) and Paxos Gold (PXGS) are two of the most liquid gold-backed stablecoins available. 

Stablecoins uses

Despite the fact that cryptocurrencies like Bitcoin and Ether are viewed as global currencies, the value of these coins is exceedingly unstable. Because the existing price valuation of these assets is unreliable, consumers and investors alike are calling for greater market stability. 

Stablecoins make it more feasible to make peer-to-peer and recurring payments more convenient. Smart financial contracts based on stablecoins do not necessitate the intervention of other parties or centralized organizations in a short while.

Top 10 Stablecoins 

Tether (USDT)

Dai (DAI)

Binance USD (BUSD)

TrueUSD (TUSD)

USD Coin (USDC)

TerraUSD (UST)

GEMINI Dollar (GUSD)

Pax Dollar (PAX)

Neutrino USD (USDN)

TRIBE

Tether (USDT) 

Tether is the first stablecoin to be accepted and issued by the Bitcoin community as a whole, and it is pegged to the US Dollar. In exchange for each Tether unit on hand, Tether Limited says it keeps a dollar in reserve. The bank account and balance of the company can be viewed by the public on the company’s website because of the company’s “transparency”.

TrueUSD (TUSD)

It is a fully collateralized, publicly validated, and legally protected ERC20 stablecoin backed by USD. It is pegged to the US dollar. Additionally, numerous escrow accounts can assist token holders in mitigating risk and providing legal protection. 

DAI (DAI)

To ensure that its value does not fluctuate over time, a novel technique is used. Unlike other fiat-based currencies, it is backed by Ethereum-based smart contracts, which enable the formation of collateralized debt positions (CDP). Since a DAI is always backed by collateral, you never have to worry about your investment’s value fluctuating.

BUSD 

The BUSD stablecoin, created by Binance and Paxos together, is a cryptocurrency linked to the US dollar. There has been an idea of one BUSD being equal to a US dollar since BUSD’s establishment, and that has been its most distinctive feature ever. To keep the value of the BUSD stable, Paxos keeps US dollars on hand equal to the whole amount of BUSD in circulation.

GEMINI Dollar (GUSD)

The Gemini Trust Company is the sole issuer of the Gemini dollar and was launched in September 2018. Gemini’s dollar reserves for its stablecoin are maintained at Boston’s State Street Bank. Currency deposits are insured by the Federal Deposit Insurance Corporation (FDIC). 

Stablecoin regulation 

Stablecoins have the ability to smooth out the historical volatility of the cryptocurrency market because they are linked to fiat currency. The volatile character of the bitcoin market may be attributable to variances in legal frameworks between countries.

Stablecoins are currently not regulated in any significant sense and there are currently no restrictions requiring issuers to safeguard their reserves or maintain steady liquidity levels. Regulations may have to be changed to allow for more competitiveness and foster innovation.

Despite the lack of broad regulations, the UK amongst other nations is critically looking at avenues to make stablecoins a means of payment in the country.

Advantages of Stablecoins

  • Cost savings are associated with transactions; low fees are attributed to international transactions and currency conversion.
  • They are ideal for investors since they are both steady and inflation-proof compared to the high volatility of other currencies.

Disadvantages of Stablecoin

  • Requires third-party intervention. External audits are also urgently required to keep track of all the company’s valuables. 
  • There is a decline in the rate of return on investment; when it comes to making money, traders and investors typically want better returns than those granted by the market. 

The Future of Stablecoin

Stablecoin regulation is expected to be a big topic in 2022 according to industry insiders. Stablecoins, like other cryptocurrencies, operate outside of the United States’ monetary system, and government officials have expressed concern that they are slipping past the regulatory framework on many occasions.

For now, the only question is what should be done about them, and who should be held accountable. With the Central Banks first focusing on regulating stablecoins and then issuing Central Bank Digital Currency (CBDCs) on multiple rails to supplement any potential weaknesses in the current financial system, stablecoins are more likely to be able to meet the needs of consumers and businesses more quickly, as well as foster a new generation of financial institutions within their borders.

This accounts for why many governments is in support of regulating these unique crypto assets, and should such regulations go mainstream, stablecoin adoption can soar in the next couple of years.

Ayo Alabi
Ayo Alabi is an experienced writer and Fintech enthusiast, passionate about educating people and helping businesses that want to see their Google search rankings surge. Her articles have appeared in a number of e-zine sites, with focus on balancing informative with SEO needs–but never at the expense of providing an entertaining read.

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