Stablecoin

A stablecoin is a fixed-price cryptocurrency whose market value is attached to another stable asset. Unlike regular cryptocurrencies, stablecoins can be pegged to certain assets, such as certain fiat currencies that can be traded on exchanges, including the U.S. dollar or euro. Some stablecoins can be pegged to other types of assets, including precious metals like gold and even other cryptocurrencies.

Stablecoins allow users to enjoy the benefits of blockchain-based digital currencies, including security, privacy, low fees, and transparency, while helping to mitigate the extreme price volatility issues faced by most traditional cryptocurrencies. People who use stablecoins to make purchases don’t have to worry about the day-to-day fluctuations of traditional cryptocurrencies. Stablecoins can also be used by businesses looking for cheaper and more efficient ways to pay overseas suppliers since they don’t have to deal with the exchange of different fiat currencies.

A stable and widely available digital and decentralized currency would also be available to people living in certain countries with unstable monetary systems and restrictive capital controls that prevent these people from purchasing goods or services in foreign currency. To hedge their investments, traders who believe their cryptocurrencies will fall in value can move their crypto assets to stablecoins.

Types of Stablecoins

Fiat Stablecoin

Fiat-backed stablecoins maintain a reserve of fiat currency (or currencies), such as U.S. dollars, as collateral that guarantees the value of the stablecoin. Other forms of collateral can include precious metals like gold or silver and commodities like crude oil, but most fiat-backed stablecoins have U.S. dollar reserves.

Commodity Stablecoin

Commodity-backed stablecoins are essentially blockchain-based representations of commodities and are backed by reserves held by a central entity. Real assets such as precious metals, oil, and real estate are used to back commodity-backed stablecoins. Gold is the most common collateral commodity. However, it is necessary to understand that the prices of these items can and will fluctuate and therefore may lose value.

Cryptocurrency Stablecoin

Cryptocurrency-collateralized stablecoins are backed by other cryptocurrencies. Because reserve cryptocurrencies can also be prone to high volatility, such stablecoins are overcollateralized—that is, the value of the cryptocurrency held in the reserve exceeds the value of the issued stablecoins.

Algorithmic Stablecoin

Algorithmic stablecoins may or may not hold reserve assets. Their main difference lies in the strategy of keeping the value of a stablecoin stable by controlling its supply through algorithms, which are essentially computer programs that run preset formulas.

Uses of stablecoins

Reduce Investment Volatility

Cryptocurrencies such as Bitcoin and Ethereum fluctuate widely in value. Assets pegged to a more stable currency can give buyers and sellers confidence that the value of their tokens will not rise or fall unpredictably in the near future.

Trade or Save Assets

You don’t need a bank account to hold stablecoins, and they are easily transferable. The value of a stablecoin can be easily transferred around the world, including in places where U.S. dollars may be difficult to obtain or local currencies are unstable.

Earn Rewards

There are some easy ways to earn rewards on stablecoin investing, often higher than those offered by banks.

Lower Transfer Fees

People can send up to $1 million worth of stablecoins with transfer fees of less than a dollar.

Convenient International Transactions

Fast processing and low transaction fees make stablecoins like USDC a good choice for sending money anywhere in the world.

Importance of Stablecoins

Although Bitcoin remains the most popular cryptocurrency, its price or exchange rate tends to be volatile. For example, the price of Bitcoin rose from less than $5,000 in March 2020 to more than $63,000 in April 2021, only to plummet nearly 50% over the next two months. Intraday swings can also be dramatic; cryptocurrencies often fluctuate by more than 10% in a matter of hours.

All this volatility is an opportunity for traders, but it turns everyday transactions like purchases into risky speculation for buyers and sellers. Investors who hold cryptocurrencies for long-term appreciation don’t want to become famous for paying 10,000 Bitcoins for two pizzas. At the same time, most merchants don’t want to end up losing money if the price of a cryptocurrency plummets after they receive a payment.

As a medium of exchange, a non-fiat currency must remain relatively stable, assuring those who accept it that it will maintain purchasing power in the short term. In traditional fiat currencies, even daily moves of 1% are relatively rare in Forex trading. Therefore, the emergence of stablecoins is very important.