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What are stablecoins? Use cases, types and examples of the most used stablecoins

What are stablecoins? Use cases, types and examples of the most used stablecoins

The cryptocurrency sector is still very young and new. With a history of about 14 years, the cryptocurrencies have already been divided into different categories such as Metaverse, NFTs, Gaming tokens, platforms, DeFi, and many others. While several of these can provide outstanding profits, most of them also come with huge risks. And to minimize risks, investors and traders also appreciate the subcategory of stablecoins, which is growing by the day.

What are stablecoins?

Stablecoins are projects, tokens, or coins that are, in most cases, pegged to different asset classes. These can be, for instance, fiat currencies such as the dollar or euro, commodities like gold, or cryptocurrencies themselves like Bitcoin or Ethereum. No matter the peg, what is crucial about stablecoins is that they need to provide price stability to their peg, which is usually denominated in dollars (1 USD = 1 USDT).

A stablecoin is basically a coin that’s pegged to another asset, and it acts almost like a reserve currency. It’s like a common denominator between other cryptocurrencies.
Humphrey Yang, Humphrey Talks

One can think of stablecoins also as a blend of the traditional fiat world with the new, emerging world of cryptocurrencies. While the main characteristics that stablecoins take from the traditional fiat world are a volatility-free and stable medium of exchange, they are also extremely fast and usually very cheap, which is something that is significant for many cryptocurrencies.

What are stablecoins used for?

Minimizing the volatility

Just from the name of this category of cryptocurrencies — “stable coins” — one can easily understand the main reason why it was created. The main goal of the stablecoins is to act as fiat currencies in the crypto world, thus limiting the volatility of price moves, which are still prevalent in the crypto space.

Simply put, while Bitcoin or other cryptocurrencies can gain or lose double digits of their value in a day, which has happened countless times before, in the case of stablecoins, this should not be the case. While the volatility risk is almost entirely diminished in the case of well-implemented stablecoins, they provide more utility to their users than one might have thought of.

Trade and save

One of the main reasons why investors or traders use stablecoins is the speed and efficiency with which they can enter trades or positions in the crypto market. Stablecoins are easily storable on exchanges or wallets and act much faster when transferring than bank accounts. This provides another key advantage of stablecoins over fiat currencies.

Cheap international transfers

On top of that, stablecoins can be sent internationally without any problems, with almost instantaneous arrivals. This is usually done for a few cents, no matter the sending amount. The past few years have provided countless examples of stablecoin transfers worth millions of dollars being sent for less than a dollar, something quite unimaginable in the fiat world.

Earn interest

Lastly, stablecoins can also act as an investment vehicle. While their investment potential is far lower than the potential of other types of cryptocurrencies, one can still use stablecoins to earn interest. There are several different ways to do so.

Earning interest on stablecoins is not the only possibility for how one can earn passive income on their crypto investments. One of the other alternatives is to use the products and services of our company, which gives plenty of different alternatives to increase personal wealth.

Types of stablecoins

As we mentioned earlier, there are different types of stablecoins. Each of them has further specifics and is unique in its own way. What are their advantages and disadvantages?

1. Fiat-collateralized stablecoins

The vast majority of stablecoins will be, without any doubt, in the category of fiat-collateralized stablecoins. To put it simply, this means that the stablecoins should be backed by fiat currencies such as dollar or euro, making their peg look something like 1 USD = 1 stablecoin. The examples of such stablecoins are Tether (USDT), USD Coin (USDC), or Binance USD (BUSD).

Some argue that collateralization by commodities, which are denominated in dollars, makes the stablecoins backed by collateral in the form of precious metals fall into this category. While it is true, it needs to be stated that only a few stablecoins are now backed solely by precious metals, oil, or other commodities, for example gold-backed PAX Gold (PAXG).

2. Crypto-collateralized stablecoins

As the name states, this type of stablecoins is collateralized by cryptocurrencies. However, since the crypto world is volatile, in this case, the peg is not 1:1 usually due to the possible drawbacks of the price. This then implies that the crypto-collateralized stablecoin needs to be over-collateralized.

This means that, for instance, to issue a 1 000 dollars worth of crypto-backed stablecoin, 2 000 dollars worth of underlying cryptocurrencies, such as Ethereum, is needed. This protects the peg in case the value of Ethereum in dollar terms falls down by 50 %. The best-known example of a crypto-pegged stablecoin is Dai (DAI), created by MakerDAO. In this case, the stablecoin is covered by Ethereum.

3. Algorithmic stablecoins

Algorithmic stablecoins are exciting but also a rather technically challenging category of stablecoins. The most significant difference between algorithmic stablecoins is that, unlike other categories of stablecoins, no peg or backing occurs in the case of algorithmic stablecoins. That is also a reason why this category of stablecoins is known as non-collateralized.

Yet, they still track a fiat currency such as the dollar to express the value that they should represent. Instead of collateral, algorithmic stablecoins use specialized algorithms and smart contracts to manage the overall supply of tokens, which should result in price stability.

For instance, the system will automatically reduce the number of tokens from circulation if the market price of the stablecoin falls below the price of the fiat currency it is tracking, and vice versa.

While this category of stablecoins is really new and only evolving, many believe that these stablecoins have the potential to become truly decentralized, which should be one of the main goals for cryptocurrencies. Examples of algorithmic stablecoins include Ampelforth (AMPL), Frax (FRAX), and Empty Set Dollar (ESD).

Best known stablecoins

While it may look like all stablecoins are the same, since they provide very similar services, some of them have had a chance to establish themselves much better in the industry than others. Let’s thus look at the most used and best-known stablecoins.

1. Tether (USDT)

Anyone, who has been following this space for at least a week, must have heard, read, or used Tether (USDT). USDT is the biggest stablecoin and the third biggest cryptocurrency by capitalization, with the current market cap sitting around 83 billion dollars, a 400 % increase since the beginning of 2021.

Tether was developed by cryptocurrency exchange Bitfinex, and has been pegged to several different fiat currencies, such as the dollar, euro, or yen, to provide a stable peg of 1 USD = 1 USDT. Tether is also one of the most traded cryptocurrencies by volume or number of transactions. This applies to daily, weekly, or even monthly numbers since almost all cryptocurrencies can be traded in a pair with Tether.

However, the users of Tether need to know that this stablecoin has been connected to various controversies. Some of them even pointed out that the peg of Tether is not real and that the treasuries and reserves of Tether do not cover the peg adequately.

2. USD Coin (USDC)

Another pretty well-known and vastly used stablecoin is USD Coin (USDC). This stablecoin was created by the company Circle and, unlike Tether, does not have that many controversies connected to its name.

This cryptocurrency is supposed to be fully backed by U.S dollars, which means that it can act as a fully digital dollar. However, it is essential to note that it was not created by the Federal Reserve, the central bank of the United States, or by the US government.

3. TerraUSD (UST)

The third biggest stablecoin at the time of writing this article is TerraUSD (UST), which has only recently taken over Binance USD (BUSD). Terra is a bit different from the previously mentioned examples of stablecoins.

TerraUSD is a decentralized stablecoin that runs on Ethereum and tries to maintain its value at 1.00 USD. Instead of a peg to a dollar, the value of UST is derived from the reserve assets of Luna Foundation. However, before that, TerraUSD was an algorithmic stablecoin. The switch was, however, rather surprising. And it is for this reason, not being fully backed by fiat, many believe that Terra, just like any other algorithmic stablecoin, might be doomed to fail. You can, for instance, read the following critique, which explains in detail the problem with algorithmic stablecoins and TerraUSD.

Conclusion

While stablecoins are not in the cryptoworld to provide a viable investment option, they are important. With more than 200 billion dollars that have been already put into stablecoins, this subsector of cryptocurrencies is more crucial now than ever before. That is why we at Crypto Investment try to pay attention to the stablecoins since they can help us create strategies that would help us deliver the best products and services for each and every one of our clients.

Published: 05. May 2022
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