What Are Stablecoins? Why Use Them? Types of Stablecoins
On Oct 28, 2020
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In the world of cryptocurrencies, we often come across the term “stablecoins” as well as the terms “Bitcoin” and “altcoins”. So, what are stablecoins? Why use them?
Stablecoin is the name given to coins whose value had pegged to another asset before it launched. The volatility issue of bitcoin or other cryptocurrencies does not happen to stablecoins. The reason is that it pegs the value exchange rate on “real” money or precious metal. These blockchain-based cryptocurrencies are designed to minimize the impact of volatility.
What Is the Difference Between Stablecoins and Other Cryptos?
The main difference between other cryptocurrencies and stablecoins is that, as the name suggests, stablecoins focus on price stability. Fluctuated price is one of the main factors keeping investors from holding cryptocurrencies. Most cryptocurrencies, as it is known, gain and lose value very quickly and suddenly. So, volatile price worries investors regarding “how could a currency go up and down so quickly?” Besides, the situation of Ethereum is not much different from Bitcoin. The only difference between these two is that Ether circulates at lower values. However, if we look carefully, these currencies are catching up with each other in terms of increasing percentages.
Usually, investors want to carry out stable and reliable financial deals. Given the volatility of cryptocurrencies such as Bitcoin and Ethereum, this can cause problems for them. At this point, stablecoins come into play. Stablecoins started to increase in popularity in 2017 after Bitcoin skyrocketed to almost $20,000. As the price of the leading cryptocurrency fell, investors were looking for a less volatile crypto-based store of value. Stablecoins seem to solve the biggest obstacle in the current cryptocurrency market. They are a kind of cryptocurrencies that you will not experience very rapid appreciation or loss. Some are pegged to fiat currencies such as the USD or Euro and others to commodities such as gold. They skip the problem of the volatility of bitcoin or other cryptos.
The Types of Stablecoins
When it comes to Stablecoin, most people think about Tether (USDT). Therefore, they believe that the stablecoin is an electronic currency which is 1:1 backed by the dollar. But, stablecoins are a broader understanding than that. Stablecoins are divided into the following four categories:
This is the most common type of stablecoins in the cryptocurrency market. As their name suggests, fiat-collateralized stablecoins are backed 1:1 by fiat currencies such as the US dollar (USD), the euro (EUR), or yen (JPY). Before circulation, a fixed equivalence is establishing between fiat currency and fixed currencies.
Fiat-backed stablecoins are created in a centralized way. It means that they are launched and even controlled by a central organization. An example of such kind of organization can be a company, a bank, or even a government. This central organization must store the same amount of fiat money that corresponds to the amount of stablecoin it offers to the market.
Tether (USDT) is the most well-known cryptocurrency among fiat-backed stablecoins, even of all stablecoins. The cryptocurrency, launched by Tether Limited, is the unique leader within fiat-backed stablecoins.
Aside from Tether, we can also add TrueUSD (TUSD), EURO Stasis (EURS), Brazilian Digital Token (BRZ) to fiat-based stable coins. The world’s valuable stablecoins, such as Gemini Dollar (GUSD), named after the famous Winklevoss brothers, and Ethereum-based USDC, also belong to this category.
While most stablecoins are pegged by real money as collateral, there is also another type of stablecoins with the commodity behind it. These are termed commodity-backed stablecoins. This commodity can be oil, gas, or precious metal like gold, and even real estate. The value of stablecoins is equivalent to underlying assets. Some of the most famous stablecoins of this category are:
DigixDAO (DGX) is one of the oldest stablecoins. DGX value is pegged to gold. One token = 0.1 gram of gold The currency inspected every three months to maintain its transparency.
SwissRealCoin is a security token backed by a portfolio of Swiss Commercial Real Estate.
Tiberius Coin (TCX) is backed-up by seven precious and base metals mostly used in the tech industry.
PAX Gold (PAGX) is another stablecoins that collateralized on the price of gold.
Petro (PTR) is the official cryptocurrency of the Venezuelan government backed by the oil barrels.
In contrast to other stablecoins, this type of stablecoins has a decentralized structure. They are backed by other cryptocurrencies. DAI by the MakerDAO platform is the most popular crypto-collateralized stablecoin. Unlike others, collateral is stored immediately on Blockchain and issued through smart contracts. This allows processes to be secure and transparent. For example, users can lock part of their Ethereum holding as collateral for borrowing DAI, which is pegged to the US Dollar.
The fourth and still relatively new form of stablecoins is called non-collateralized. They are not backed by anything at all and governed by an algorithm-based supply-demand elasticity mechanism. This concept is known as Seigniorage shares and invented by Robert Sams in 2014.
Seigniorage shares are managed by “smart contracts.” When the price of a Stablecoin is too high due to increased demand, the algorithm will increase the total supply, and when the price decreases, the supply will be decreased. Carbon, Steem Dollar, Bitpay Official, Nubits are some common stablecoins of this category.
Why Use Stablecoins?
The most common argument is stablecoins offer an efficiency advantage over traditional cryptocurrencies. Traders or investors convert their assets to fixed currencies to avoid the volatility of cryptocurrencies. They are protecting themselves from market volatility by holding stablecoins instead of cryptocurrencies like Bitcoin and Ethereum.
ShapeShift CEO Erik Voorhees made the following statement regarding stablecoins.
“ Stablecoins are important in the same way that a bridge is important. You may not care much about the bridge, but without it, the beautiful land beyond is much harder to get to.”
Stablecoins are an encouraging currency, especially for those who want to enter and get to know the cryptocurrency world. This is because these cryptocurrencies do not require too much dedication or encouragement from timid investors. Stablecoins contribute support for the financial services ecosystem as a whole.