Why do we need stablecoins?
A cryptocurrency is a decentralized, peer-to-peer digital currency that can be transferred to and from everyone in the world instantly and anonymously. Unlike fiat currencies, which are governed by banks and government regulations, cryptocurrencies are not issued or controlled by any monetary authority.
In other words, their value is purely dependent on market sentiment.
Inevitably, the market sentiment fluctuates. By a lot. This causes price volatility. You never really know how much it may be worth!
To counteract the market instability faced by cryptocurrencies such as Bitcoin and Ether, the crypto world came up with stablecoins. A stablecoin’s value is pegged to a real and stable commodity such as gold or fiat currencies. Stablecoins, like other cryptocurrencies, are digital currencies that do not have a physical presence and can be exchanged on exchanges all over the world.
Many stablecoins are collateralized at a 1:1 ratio with fiat currencies that can be exchanged on exchanges, such as the US dollar or the Euro. Other stablecoins can be linked to a variety of properties, like precious metals like gold or even a collection of cryptocurrencies.
This means that if you buy a stablecoin that is pegged to the US dollar at 1:1, which means that 1 stablecoin is equal to $1. You can sell it and get your $1 back at any time.
Stablecoins combine the advantages of cryptocurrencies — such as transparency, protection, immutability, digital wallets, quick transactions, low fees, and privacy — with the confidence and stability of fiat currencies. The applications, as you can guess, are immense!
Stablecoins Explained: What are the uses of Stablecoins?
- Stablecoins are most often used to secure the value of holdings by rapidly switching between a volatile cryptocurrency and a stablecoin when trading. If a trader owns Bitcoins and expects the price to drop, they can almost immediately exchange them for stablecoins to cover their holdings. Stablecoins, like gold, provide traders with a haven where they can reduce their exposure to crypto-assets without having to abandon the crypto ecosystem. This is true for any stablecoin!
- The key goal is for stablecoins to become commonly used as a medium of exchange in the future. “Stablecoins aim to accomplish the functions of conventional money without relying on trust in an issuer — such as a central bank — to stand behind the money,” says Lael Brainard, an American economist and member of the Federal Reserve Board of Governors.
- Stablecoins can be used in tandem with smart financial contracts. Smart contracts are self-executing contracts that run on a blockchain network and do not require the intervention of a third party or a central authority. These traceable, straightforward, and permanent transactions are perfect for salary and loan payments, rent payments, and subscription payments. A company, for example, might set up a smart contract that transfers stablecoins to its employees’ accounts automatically at the end of each month.
- People can easily swap their savings for USD-backed, Euro-backed, or even gold-backed stablecoins if their local fiat currency crashes, avoiding further depreciation of their savings.
What is the significance of stablecoins?
According to the World Bank’s Global Findex data from 2018, 1.7 billion adults were unbanked in 2017. In 2017, China had 225 million unbanked adults, while India had 190 million. According to a 2017 study conducted by the Federal Deposit Insurance Corporation, 25% of American households are either unbanked or underbanked (FDIC).
Stablecoins can work for this large unbanked and underbanked population as a digital currency used to make payments all over the world. After all, stablecoins can substitute conventional currency to allow quicker, more secure, simpler, and cheaper cross-border payments for anyone from migrant workers to companies making payments to overseas suppliers or employees.
According to a McKinsey Global Payment Report 2019, global cross-border payments revenue was projected to be $230 billion in 2018. About 250 million people spend over $500 billion in remittances per year.
In 2020, the average cost of sending money around the world will be around 7%.
In contrast, transfer fees for crypto in general are not nearly as high. See why they exist? Henri Arslanian, Chairman of the Hong Kong FinTech Association and Global Crypto Pioneer at PwC, says that stablecoins have the potential to make a big difference in the cross-border payments market.
Stablecoins List: What types of stablecoins are there, and how do they work?
- Algorithmic stablecoins
Robert Sams proposed the first reliable stablecoin in a 2014 paper titled, “A Note on Cryptocurrency Stabilization: Seigniorage Shares.”
He proposed in his paper that a new coin be created, a peg be set, and then the price on the exchange be monitored. Sams’ proposal demonstrated how all of this can be accomplished algorithmically, decentralized, and with open source code that is publicly available and auditable.
Let’s look at a quick example to see how the algorithm operates. Assume you make a new currency and peg it to the US dollar, meaning one new coin equals one dollar.
If your coin’s price rises above $1, it means the demand for your new coins is too high. The algorithm prints more coins to increase the supply of your new coin until demand equals supply at the price peg.
If your coin’s price falls below $1, it means there are so many coins in circulation and demand is greater than supply. The algorithm is set up to reduce the number of coins in circulation until supply and demand at the dollar price point are balanced.
Even though Robert Sams’ Seigniorage Shares were never launched, his famous paper laid the groundwork for a new class of stablecoins known as Algorithmic Stablecoins, also known as Non-Collateralized Stablecoins.
The currency because it is programmed with freely auditable code. These are the most decentralized and open stablecoins.
- Fiat-collateralized Stablecoins
Among Stablecoins, fiat-collateralized ones are the most common. These Stablecoins are pegged to fiat currencies such as the US dollar or the Euro and are normally backed at a 1:1 ratio, which means that for every stablecoin in circulation, there is a fiat currency in a bank account.
To better understand fiat-backed coins, consider Tether: the top stablecoin in the world in terms of market cap. Tether is pegged to the US dollar at 1:1. In other words,one Tether is worth $1.
The Tether process is as follows: an exchange that trades in Tether has a bank account, and for every Tether coin purchased from the exchange, the exchange deposits $1 into the bank account.
Tether coins and dollars may be exchanged and redeemed directly from the exchange at any time.
Fiat-collateralized stablecoins have the disadvantage of not being open or auditable by anyone. As a result, consumers must have faith in the operator to trade in these currencies, as there is no way to verify whether or not the exchanges are following procedure. This was part of the controversy around Tether in 2017.
While they are the easiest form of the stablecoin to understand, one criticism against them is that they restrict the true potential of cryptocurrencies since they serve as proxies for fiat currencies.\
- Crypto-collateralized stablecoins
This list of stablecoins contains cryptocurrencies that are connected to other cryptocurrencies. Unlike their fiat-backed counterparts, these currencies are far more transparent, have open source codes, and can be run in a decentralized manner since all take place on the blockchain.
Since cryptocurrency prices are volatile, stablecoins are often backed up by a diversified pool of cryptocurrencies that can withstand shocks while remaining stable.
Over-collateralization is another process, in which the ratio of collateralization rises.
For example, if a crypto-backed stablecoin is pegged 1:2, a cryptocurrency worth twice the value of stablecoins would be kept in reserve for each stablecoin. In other words, the stablecoin is said to be 200 percent collateralized.
This is done to keep the price of stablecoins consistent. Even if the collateral cryptocurrency’s price drops by 25%, the stablecoins would maintain their original value because the collateral’s value is still greater than the value of the stablecoin.
If the collateral cryptocurrencies’ values drop below a certain threshold, the stablecoins are configured to immediately liquidate to preserve their value, minimizing risk for traders.
Dai, by MakerDAO, is the most common crypto-backed stablecoin. Its face value is pegged to the US dollar, but it is collateralized by Ethereum.
- Commodity-collateralized Stablecoins
This list of stablecoins contains digital currencies backed by stable assets such as precious metals, gold, real estate, and oil. This potentially means to investors that these stablecoins can appreciate in tandem with the value of their underlying assets, increasing the motivation to retain and use them.
Digix Gold (DGX), for example, is a gold-backed stablecoin, with 1 DGX equaling 1 gram of gold. This gold is held in a Singapore vault and is audited every three months to maintain transparency.
Where to Buy Stablecoins
At CryptoLocally, users can trade top stablecoins directly with one another, or even buy stablecoins from fiat. CryptoLocally is an ideal peer-to-peer network with support for several top stablecoins available for trade in a trustless manner, with escrow. These include the best stablecoins, such as USDT ERC-20, USDT TRC-20, and USDC!
