A stablecoin is a cryptocurrency that functions similarly to other cryptocurrencies but differs in volatility. Unlike other cryptocurrencies, they promise stable value.

Stablecoins are pegged to or backed by other currencies or commodities, such as the US dollar or gold, to maintain their stable value.

Why and When Were Stable Coins Invented?

Early adopters began to accept Bitcoin as a new payment standard due to its accessibility, convenience, speed, and security regardless of location. The only problem was its notorious volatility.

Even today the biggest cryptocurrencies like Bitcoin and Ethereum suffer wild swings of more than 10% in just a couple of hours.

Such volatility can be scary, especially for merchants who accept crypto payments. Just imagine the face of the person whose crypto payment plummeted moments after being received.

To avoid such traumatic facial reactions, the first stablecoin, BitUSD, was introduced in 2014. It was released on the BitShare blockchain as a token by two eminent Blockchain leaders, Charles Hoskinson and Dan Larimer.

The Advantages of Stablecoin

Since its inception in 2014, stablecoins have become an important aspect of people’s lives, which is visible given their massive market caps. The cumulative market cap of the top 10 stablecoins touched $160 billion in March 2022, according to Statista.

Here is a list of stablecoin benefits that serve as the driving forces behind their widespread success.

• Powered by Blockchain- The only reason why Bitcoin’s growth is hindered as a medium for exchange is its wild volatility. Stablecoins solve this by incorporating Bitcoin’s essentials — a tamper-proof transaction ledger with no third-party involvement — while mirroring real-world currencies.

  
  

• Cross-border remittances- The whole world knows how cross-border remittance was a pain in the ass before the vogue of cryptocurrencies. Stablecoins made remittances even more doable with their stable value and other benefits of cryptocurrencies, such as security, speed, and transparency.

  
  

• Safe to invest- Unlike most cryptocurrencies, stablecoins are a safer investment as tangible world assets or financial instruments back them.

  
  

• Protection for traders- Stablecoin is the best option for traders to flip their crypto during turbulent market conditions. It is very convenient to convert cryptocurrencies like Bitcoin and Ethereum to Stablecoin compared to fiat conversions.

Why Do Stablecoins Need Backing?

Since Stablecoins are not legal tender, there must be a reason to trust them. Hence, stablecoins are backed by different real-world commodities and currencies. By becoming entangled with or pegged to more established traditional investments, they boost market confidence. As a result, they are often the go-to option for institutional and retail investors.

Based on what is used to back or collateralize a stablecoin, there are 4 types of stablecoin.

4 Different Types of Stablecoins

Let’s learn about each of the stablecoin types in brief.

Fiat-Collatarized Stablecoin

Fiat-collateralized stablecoins are the most popular ones, backed by fiat currencies such as USD, EUR, or GBP at a 1:1 ratio, meaning each stablecoin can be exchanged for one unit of the fiat currency. This type of stablecoin maintains a reserve of one or multiple fiat currencies as collateral to maintain its peg.

Companies that offer such stablecoins must ensure that the number of minted coins doesn’t exceed its fiat counterparts. i.e. If there are a total of 1 billion tokens in circulation, then the fiat reserve must also equal 1 billion.

Tether, Gemini Dollar, and USDP are some examples of fiat-collateralized stablecoins.

Commodity-Collatarized Stablecoins

The commodity-collateralized Coins are backed or collateralized by valuable real-world commodities such as Gold, Platinum, Oil, or even Real estate. Collateral or commodity used to back the stablecoin is often reserved in third-party vaults.

Gold is the most common commodity used to back stablecoins, which has a proven track record of value appreciation. Some popular examples include Tether Gold (XAUT) and Paxos Gold (PAXG).

Crypto-Collatarized Stablecoins

A crypto-collateralized stablecoin is backed by other cryptocurrencies, as you’d have already guessed from the name. Since cryptocurrencies are highly volatile, a 1:1 ratio doesn’t work here: the reserved cryptocurrency for backing must be at least 2–3 times more than the stablecoin to maintain the peg.

Examples include WBTC, Dai, and BitUSD, among others.

Algorithmic Stablecoins

In Algorithmic Stablecoins, Collateral is replaced by an Algorithm, unlike other collateral-based coins. This means the price stability of the coin pegged to any asset(could be fiat or gold) relies on algorithmic mechanisms instead of collateral such as currencies or commodities.

The algorithm constantly works to maintain supply, i.e., if the price rises, the algorithm will modify itself to issue more coins, and if the price falls below the pegged value, the algorithm sells the coins.

Some examples include Frax Ampleforth (AMPL), Kowala (kUSD), Frax, etc.

Are Stablecoins Safe?

I completely got baffled while looking for this question’s answer. But I eventually got some idea. If you go back a little back in history, you’ll see there have been multiple stablecoin Fiascos. And most of them are related to Algorithmic Stablecoins; the latest TerraUST fiasco is a spine chiller.

Does that mean collateralized stablecoins are safe?

The answer to this could’ve been a yes, but since the market for stablecoins is highly unregulated, we can’t say anything. Even the most successful stablecoins have failed to justify their name(Stablecoin) as they often lose their peg.

What further exacerbates the trust factor is that the most successful stablecoin is also the most controversial.

Tether, or USDT, the biggest stablecoin by market cap, refuses to go under an audit. The excuse they rely on is they don’t want regulators to know how US dollars turn into Tether.

But despite all the chaos in the stablecoin market, it is not sufficient to say you should avoid it. Stablecoins are unavoidable as they are an offering considered the best of both worlds between traditional currency and crypto.

Buying cryptocurrencies with stablecoins is so convenient. So, I won’t be robbing you of your pleasure of buying a stablecoin. Below are the steps you should always consider before choosing your stable cryptocurrency.

Choosing an ideal Stablecoin.

Traditional Backing

The peg of a Stablecoin entirely relies on what’s backing it. If the commodity that backs it is a volatile cryptocurrency, the chances of de-pegging are high. Any stablecoin backed by proven traditional world commodities such as Gold or the US Dollar can be a good option, at least for now.

Transparency

Before buying a particular stablecoin, you must also research the company issuing these coins. Does the company perform regular audits? Is the company transparent? These are some of the critical questions to consider.

USDT vs USDC

Both of these are the top 2 Stablecoins as per market cap, but the reason why critics choose USDC over USDT, is pretty straightforward: USDC is issued by CENTER — a joint venture between CIRCLE and Coinbase. Both of which are well-known names that operate transparently. Moreover, an independent third party audits USDC’s 1:1 ratio with USD.

In the case of USDT, the number one stablecoin, it is still under scrutiny by legal organizations. Some lawsuits have also claimed earlier that it doesn’t maintain the 1:1 peg. The latest quarterly assurance report for 2022 Q1, released by Tether, shows that the company has reduced its commercial paper holdings. The report also highlighted Tether’s safe treasury bill’s increased holdings.

But since $12bn of the $82bn is still held in loans and other assets, we can’t say if cash equivalents of $82bn fully back it.

Future of Stable Coins

It is evident that cryptocurrencies are here for the long haul. No matter how often punitive Governments tried to beat them down, the craze for them is unlikely to wane. Stablecoin, on the other hand, are cryptocurrencies that offer stability — a thing that the whole world craves.

Stablecoins are something people genuinely need because of the benefits they bring to the table. TerraUST’s tumble is, of course, a spiteful event and has caught a lot of regulatory attention. The US congress might even pass legislation anytime soon to create a regulatory framework for stablecoins, as revealed by Janet Yellen.

While a regulatory framework would address many of the issues preventing stablecoin adoption, we can’t comment on what implications can come with it.

The story was first published here.