Last but not least, Stablecoins are an essential part of all the categories of coins and needed their chapter.
Cryptocurrencies are the most volatile assets you can find in the financial markets. Since it is hard to get cryptocurrencies regulated, most exchanges are not allowed to let you trade cryptocurrencies with fiat currencies (USD, EUR, CNY, etc…). Thus, cryptocurrencies pegged to assets with stable values (such as USD) have been created. A stable coin will then see its value fixed and then stable. The most famous stable currency is the USDT, backed by U.S. Dollars. 1 USDT is the equivalent of 1 Dollar U.S.
Because of Stable Coins, people may now be invested in cryptocurrencies without caring about their overall worth because they still can switch to USDT, thus being assured of having a stable wealth when they are not in any trade.
What is a stablecoin?
Behind every Cryptocurrency is usually a company, or a group of people, trying to carry out a project. While projects are usually different from each other, some of them may have common points and try to achieve the same goal.
For example, many cryptocurrencies are classified as “stable coins”. These cryptocurrencies tries to bring stability to this extremely volatile market. The special feature of stablecoins is that their value is always supposed to remain constant in euros or dollars. This is regardless of the value of Bitcoin or the market as a whole. Thus, a stablecoin will always be worth €1, or $1 for example.
Let’s take a look at why this type of cryptocurrency was created and what are its advantages?
Why were stablecoins created?
You are not without knowing that to get altcoins, you must, first of all, get Bitcoin or Ethereum on sites like Coinbase. Then you will have to transfer these cryptocurrencies on exchanges such as Binance or HitBTC.
When you want to take your profits (if you have any), you will have to reconvert these cryptocurrencies into BTC and send them back to Coinbase. You will then be able to convert them into euros or dollars. This is a bit tedious and you will have to pay a transaction fee each time.
That’s how the system works because very few exchanges allow you to trade directly with fiat money.
Now, let’s say you want to have some of your money in fiat (€, $…) and some in cryptos. However, you want to leave your fiat on exchanges so that you can take advantage of a good opportunity that may arise. In theory, this is not possible because you have to make transfers to sites that allow you to do the fiat/crypto conversion.
This is where the famous “stablecoins” come in. Most of the exchanges have one that allows you to play the role of money (fiat). So, if you want to have some of your money in euros or dollars, you can buy a “stablecoin” that will always (in theory!) be valued at 1$.
Thanks to this system, no more laborious and expensive transfers between exchanges. You can convert instantly and at low cost a part of your cryptocurrency into an asset that will “always” keep a fixed value against the dollar.
The different existing stablecoins
Fiat-Backed Stable Coins
These coins are designed to be fully backed by fiat money (USD, EUR, CNY, etc…). For example, the USDT Token (Tether) is backed by U.S. Dollars. 1 USDT is equivalent to $1. This category of coins also enters in the centralized cryptocurrency category.
A central authority is managing the acceptance of new fiat and can “print” a corresponding amount of stable coins. The company behind the USDT, Bitfinex, is ensuring its customers that real dollars back the currency. However, as this cannot be verified, it requires a degree of trust that some people may not have, like Roche Freedman, a New York-based legal firm, for example.
The advantages of Coins reside in the simplicity of use and understanding, as well as the stability offered. However, they are against the goal of cryptocurrencies, by being centralized, and thus, requiring trust. The lack of regulations in this domain can involve mass manipulation, like some Tether FUD, or printing of new money, manipulating the price.
Most used Fiat-Backed Stable Coins are pegged to the U.S. Dollars, so we will only quote a few of them:
- Tether (USDT)
- TrueUSD (TUSD)
- Binance USD (BUSD)
As per Fiat-backed stable-coins, Commodity-backed stable-coins are backed by commodities. The most common commodity in reference is Gold. Gold is reputable to be a good Store of Value asset, which makes it interesting to hold during a crisis period.
For gold-backed stable-coins, the coin represents a specific value of Gold – for example, 1 gram of Gold – while the physical Gold itself is stored in a 3rd party’s vault.
Commodity-backed stable-coins are considered as a viable alternative to Fiat-backed stable coins. They are also an easy way for people invested in cryptocurrencies to diversify their investments.
The biggest example of commodity-backed stable coin is the Digix Gold Token (DGX).
Cryptocurrency-Backed Stable Coin
The last two categories are the less known and used by people but can be interesting to use. Cryptocurrency-backed stable coins are pegged to another digital currency with a large market capitalization, e.g., Bitcoin. In reality, cryptocurrency-backed stable coins are pegged to multiple digital currencies for better risk distribution.
The real advantage behind Cryptocurrency backed stable coins is a total decentralization and its efficiency. They can also be used to create leverage for trading. However, since the underlying assets are cryptocurrencies, they can be much more volatile than any other stable coins.
The most ambitious cryptocurrency-backed stable coin on the market is the DAI from MakerDAO.
Seignorage-Style Stable Coins
Seignorage-Style Stable Coins are an algorithmically governed approach to expanding and contracting a cryptocurrency’s money supply. With more straightforward words, they use algorithms to increase or decrease stable coins to copy the way central banks are managing their countries’ monetary supplies.
Seignorage-Style Stable Coins gives the advantages of being autonomous and decentralized. They offer better stability and is supported by many financial technology experts. However, the rule-based system is complex and makes it hard to understand for the average investors. This new technology also has no proof of being successful in the long term.