To combat high volatility and increase participation in a larger community, crypto projects are incorporating price stability directly into their digital assets, bringing about a whole new subset of cryptocurrencies in stablecoins.
As their name suggests, stablecoins are intended to be volatility-minimized assets whose price mirrors fiat currencies such as the U.S. dollar. To fully understand the potential of stablecoins and how they work in tandem with more volatile cryptocurrencies, we need to dive a little deeper.
A stablecoin is a type of cryptocurrency whose value ties to another “stable” asset like the U.S. dollar, euro, or gold.
Most largest cryptocurrencies by market-cap, on the other hand, are volatile. Many argue that these assets are difficult to use as a means of payment because of this volatility. For example, the value of one Bitcoin at one point could only buy a candy bar in 2010, but the same Bitcoin today may be equivalent to the price of a car. There are other cryptocurrencies whose value has decreased by as much as Bitcoin's value has risen. As a purchaser, you want some stability in the asset you transact.
Stablecoins offer an alternative option by reducing this volatility, potentially making them more suitable for regular use. Borderless payments, low transaction fees, self-custody, and a combination of conventional fiat currency stability with digital asset flexibility make stablecoins appealing to millions. To understand why, we must first know how stablecoins work.
Bitcoin (BTC) is not a stablecoin. Stablecoins aim to maintain a stable value through fiat currencies or other assets like gold. Bitcoin’s value is volatile in comparison. To learn more about Bitcoin click here.
Stablecoins seem to be a promising asset on paper, but what can we do with them? Are they practical enough for real-life use? The answer is yes. Here are a few ways we can use stablecoins to earn interest and transfer money:
Many traditional fiat currencies are prone to inflation, especially in economies with high interest rates. On the contrary, currencies like the US dollar or the euro have been more resistant to inflation in the past 20 years. Stablecoins like Tether and USDC are pegged to the US dollar, meaning they may inflate less than local currency. Individuals can exchange their money for stablecoins and get exposure to US dollar inflation, allowing their money to maintain more of its value.
As a result, stablecoins enable users to have the same store of value opportunity as US citizens, no matter where they are from. Any individual with internet access can use stablecoins to transact daily.
Stablecoins come in various types. Each employs a mechanism to stabilize their value.
Fiat-backed stablecoins aim to maintain a reserve ratio of 1:1 with its respective currency. For example, Tether is pegged to the US dollar at a 1:1 ratio, meaning that one unit of tether should be backed by one unit of US dollar and the total market cap of tether should be backed 1:1 with assets.
A central bank digital currency (CBDC) is an electronic version of a fiat currency. The key difference between existing cryptocurrencies and CBDCs is that the latter is government-backed and issued by a country’s central bank. CBDCs are tied to the value of the issuing government.
Let’s look at the different types of stablecoins to understand how they’re backed:
Now that we’ve understood the different types of stablecoins and how they work, it’s time to look at the most popular stablecoins available on the market.
With a market capitalization of around $65 billion, Tether is the world’s most popular fiat-backed stablecoin. It was also the first stablecoin on the crypto market and has the highest number of global transactions, making it the most liquid stablecoin. There have been accusations that USDT is not backed 1:1 like they claim, although this is yet to be proven.
As the name suggests, USD Coin ties to the value of the US dollar. It is a fiat-collateralized stablecoin. This means one can buy one USDC for $1 or redeem one USDC for $1 at any given time. At the time of writing, a total of 55.8 billion USD Coins are in global circulation.
Currently the third-largest stablecoin by market cap at $17.5 billion, Binance USD is a fiat-backed stablecoin project initiated by the crypto exchange platform Binance in collaboration with Paxos. BUSD maintains a 1:1 ratio with the US dollar and is approved by the New York State Department of Financial Services (NYDFS).
MakerDAO launched Dai on the Ethereum blockchain in 2017. Dai, a cryptocurrency-backed stablecoin, uses ether (the cryptocurrency on Ethereum’s platform) as backing, while its value ties to the US dollar. Unlike other stablecoins, DAI is decentralized and uses smart contracts and incentives as the mechanism to maintain its peg.
TrustToken’s TUSD is a fiat-collateralized stablecoin that exists on the Ethereum blockchain. Each TUSD token currently maintains a 1:1 ratio with the US dollar. Users can mint and redeem TUSD tokens on TrustToken's website.
Stablecoins may seem like the best of both worlds. However, they carry their own risks.
Buying stablecoins is the gateway to most marketplaces. Rather than watching the fiat currency value fluctuate while deciding on the next trade, stablecoins offer a way to ensure an purchase holds roughly the same value between trades. While this is a great shelter from volatility, it’s upside is capped at that of the pegged asset. Users may be protected from sharp decreases in value for the most part, but they can’t expect much in the way of increased returns, either.
Worldcoin, a new cryptocurrency but not a stablecoin, aims to give every human on Earth a free share without compromising privacy. At Worldcoin, we aim to increase individual empowerment and equality of opportunity globally. Subscribe to our blog for more news and information on the world of cryptocurrency!