The inception of Bitcoin in 2009 has resulted in a revolution in the trading and payments industries. People have started to accept cryptocurrencies as a form of payment and it’s being exchanged in large volumes. Due to the increasing demand for cryptocurrencies, developers are continually launching new cryptocurrencies with fewer loopholes. These can be used for global transactions, buy new assets, and at your nearby retail stores.
Even though many stores accept Bitcoin and other cryptos as a method of payment, it’s rare to see crypto holders use it in their daily transactions. Another argument might be that there aren’t enough shops that accept it. The main reason behind this is the volatility of cryptocurrencies. So, Stablecoins are cryptocurrencies developed for this particular reason. It’s more stable than other cryptos since it’s backed by a standard like gold or dollar.
Stablecoins have become a quite popular crypto asset due to its stable prices, low costs, and security functions. It has become a go-to choice for asset holding for investors. Now, several questions linger. Should you invest in stablecoins? What are they actually? How are they fundamentally different from regular crypto assets like Bitcoin? Let’s discuss this category of cryptos in detail.
Understanding Stablecoins: Definition and Examples
A stablecoin is a digital asset which is backed by another asset like gold and fiat currencies. The backing of stablecoins helps it to become price-stable. With stablecoins, you get the advantages of both worlds, i.e., price stability of fiat currencies and security and high speed of cryptocurrencies.
So, you can transfer and receive stablecoins in P2P (peer-to-peer) mode in real-time. You also get the best security you want with encryption, cryptography, and hashtag.
Stablecoins are increasing in demand day-by-day. Over 200 stablecoins have been launched until now. About 30% of these are active, 10% are discontinued, and 60% are in the R&D stage. The total volume of stablecoins has breached the 12 billion mark in 2020. Earlier this year in June, the total value of stablecoins transacted exceeded that of Bitcoin for the first time ever.
Now, let’s see five of the most popular stablecoins.
USD Coin: The USD Coin is a top stablecoin that was launched by a collaboration of CENTRE with Coinbase, Circle, and Consortium. USD Coin, similar to Tether, is backed with the US dollar in the ratio 1:1. Its fundamentals are based on the blockchain technology used by the Ethereum coin which ensures secure and fast transactions at lower costs. It has a market capitalization of over $1.1 billion.
Tether: It’s the oldest and the best stablecoin available in the crypto world. Tether has a market cap of more than $10 billion which indicates its popularity amongst crypto enthusiasts. It’s pegged to the US dollar, in terms of value, in a 1:1 ratio.
Dai: Created by the developers of the cryptocurrency, Maker (MKR), Dai is another popular stablecoin. It’s managed by the team at the Maker community. Like Tether and USD Coin, 1 Dai equals 1 USD or they’re pegged in a 1:1 ratio. The stablecoin is compatible with over 400 apps, websites, and services. It’s one of the newest stablecoin with a market cap of $50.16 million.
TrueUSD: TrueUSD is regarded as the most consistent and reliable stablecoin in the market. It’s also backed by the US dollar and has a market cap of close to $138 million.
Paxos Standard: Pax or Paxos Standard is another top stablecoin which has the ability to adapt to different needs of crypto investors. It has also been authenticated by the New York State Department of Financial Services. 1 Pax is pegged to 1 USD or in a 1:1 ratio. You can exchange the coin for USD but it’ll destroy your crypto tokens.
Now, stablecoins have been a revelation for the Financial Technology (FinTech) industry as well. Let’s look at its advantages to FinTech.
Unlike some other types of cryptocurrencies, stablecoins are based on blockchain technology – the core idea behind cryptocurrencies. Because of this, you get features like transparency, better security, and accountability from stablecoins, like cryptos.
Reduction in Price Fluctuations
The main function of stablecoins is that it’s price-stable. So, you obtain all features of cryptocurrencies devoid of serious price fluctuations. For this, most crypto assets are backed by a standard such as the US dollar or gold.
Advantages of Both Worlds
Stablecoins offer better security and faster transactions like other cryptos like Bitcoin. You also receive the benefit of price stability which is lacking in Bitcoin, Ethereum, and other major cryptos.
This type of crypto is also compatible with hundreds of apps and services. You can use it for various purchases and other transactions in the dApps network.
Classification of Stablecoins
There are primarily four types of stablecoins, classified on the basis of the asset standard used for backing-
Stablecoins that are backed by a cryptocurrency are called as crypto-backed or crypto-collateralized stablecoins. It’s necessary for such stablecoins to keep a large reserve of the cryptocurrency used for backing to cover price fluctuations. The ratio of backing isn’t 1:1 like in the case of fiat-backed stablecoins. At least 2-3 cryptos are used as collateral for one stablecoin.
Dai and BitUSD are two examples of crypto-backed stablecoins.
We looked at such stablecoins before. They’re the most common type of stablecoin. These types of stablecoins are backed by fiat currencies like GBP and USD in a 1:1 ratio. So, for example, if USD is the backing standard, one USD is used as collateral for every unit of the stablecoin. Tether and TrueUSD are some of the fiat-based stablecoins.
These types of stablecoins are quite similar to fiat-backed stablecoins. The primary difference between them is that a commodity like gold or other precious metals is used as the backing standard. HelloGold and DigiX are some of the stablecoins backed by precious metal commodities.
Such stablecoins aren’t backed by any commodity, cryptocurrency, or fiat currency. So, do they violate the main principle of stablecoins? No, they’re dependent on a complex algorithm that purchases and sells stablecoins to regulate its prices and maintain price stability. Kowala kUSD and Carbon are examples of such stablecoins.
The Rise of Stablecoins
Crypto investors have realized the importance of long-term, safe, and risk-free investments during the ongoing pandemic. This has led to a huge increase in the demand for stablecoins. Investors are now moving away from risk-high cryptos like Bitcoin and Ethereum and towards price-stable cryptos.
This growth is evident in the numbers. It took 5-6 years for the supply of stablecoins to cross the 6 billion mark, while it surged past the 12 billion mark in only four months (March to July).
Coinmetrics, the renowned crypto data-analysis company, reported that some of the major stablecoins, including Paxos Standard, USDC, Tether, Gemini Dollar, and Binance Dollar experienced explosive growth in their total market capitalization. There’s been a 700% increase in the demand for USDC in the first quarter of 2020.
Emergence of CBDCs (Central Bank Digital Currencies)
The rise of stablecoins has allowed authorities and governments to explore and invest in decentralized technology. CBDCs can improve the transparency and traceability of crypto transactions. Many financial authorities around the world are looking to launch their own stablecoins in their countries.
The Bank of England is striving towards leveraging crypto transactions through decentralized technology. They’ve also published a discussion article on CBDCs.
The central bank of China, the People’s Bank of China, is currently developing digital Yuan. Even though there has been no news regarding the launch date, sources report that pilot tests are being executed.
Digital USD is also becoming popular in the United States. Recently, the US legislation passed a bill that would allow digital dollar, a CBDC, to be used as a payment method.
Libra by Facebook
Facebook has been vocal about its aspirations to launch a cryptocurrency that has most of the features of a stablecoin, i.e., fast, secure, and price-stable. They recently launched their brainchild, Libra, a stablecoin backed by myriad securities and assets. It’s believed that the crypto asset will change the way crypto transactions are done. Libra will allow the exchange of crypto assets through a texting app. It’s also supposed to lower transaction costs.
After its launch, major companies like Uber, PayPal, Visa, and MasterCard invested in it. However, many experts believe that Facebook’s Libra is going to facilitate money laundering, endanger users’ privacy, and destabilize monetary policies. This has caused many companies to withdraw their support.
What the Future Holds for Stablecoins
The Financial Technology (FinTech) industry is currently involved in developing methods of digital payments that are more technologically advanced. Due to the price stability offered by stablecoins, it can help in tough times like the pandemic where every other asset market is falling. It can also facilitate quick and secure transactions.
Stablecoins are the ideal crypto asset that regular people can invest in. It opens the horizon for the crypto market. They are the way to go if crypto transactions are to be promoted.