The price of assets in coins like Ethereum and Bitcoin completely depends on supply and demand in the market. Since a centralized body does not regulate these coins and are not recognized as official state money, their value may fluctuate.
However, stablecoins have been introduced, providing a secure exit strategy to mitigate this volatility. Let’s go into the blog to learn more about stablecoins in-depth.
As the name suggests, any digital or crypto asset with a stable value compared to the conventional monetary asset is called a stablecoin. Stablecoin’s value is backed by low-risk assets such as fiat currencies or gold, which lowers price volatility. A single fiat currency, a group of currencies, or additional valuable assets could be the backing asset.
Stablecoins seek to balance the volatile nature of digital assets by building a more stable and dependable environment to promote the adoption of digital currencies. They combine the stability of cash currencies with the safety and decentralization of cryptocurrencies to provide you with the ideal combination.
In the cryptocurrency world, BitUSD is credited as being the first stablecoin, which was originally introduced in 2014. These assets were designed to balance real-world fiat stability and the decentralization, speed, and security of cryptocurrencies.
Numerous other stablecoins have been developed since then, using various strategies to keep their value constant. Most stablecoins are fiat-collateralised because they are backed by a reserve of fiat currencies like the U.S. dollar, euro, or Japanese yen.
The DeFi market flourished in 2020 and 2021, which led to increased usage of stablecoins as more were generated to satisfy the increased demand for stable assets on the cryptocurrency market.
In addition to providing a safe and secure monetary system for investors and users to make regular transactions, stablecoins shield users against price inflation and financial eviction.
Despite the extreme fluctuations of other major cryptocurrencies such as Bitcoin and Ethereum, stablecoins have remained one of the few token categories that have upheld market capitalization since their introduction, both in bullish and collapsed markets.
Regarding market capitalization, most cryptocurrencies can connect. However, stablecoins vary from most cryptocurrencies. Stablecoins’ comparatively stable market capitalization may suggest that most users aren’t exchanging their stablecoins for cash. Stablecoins are more likely to remain part of the cryptocurrency ecosystem instead.
Fundamentally, for each stablecoin that is put into circulation by an exchange that offers a fiat-backed stablecoin, a dollar, or the currency to which its coin is pegged, is deposited. Because of this, the stablecoin is tied to that currency and, in theory, owners of stablecoins can convert them into fiat money at a 1:1 ratio. Stablecoins in circulation are chained to other assets, but fiat-backed stablecoins account for most market capitalization.
The types of stablecoins vary in the backup they have from various assets; the most common types include fiat-backed stablecoins, commodities-backed stablecoins and algorithmic-backed stablecoins. Let us now discuss these three types in detail for better understanding:
The first and most widely used approach is to use fiat money or cash equivalents to support each stablecoin in circulation to the same level. The most straightforward method of connecting a token’s value to the U.S. dollar is to support it with an equivalent number of reserves kept in a bank account. It indicates that the issuer’s U.S. bank accounts are held in reserve equal to one USD for each stablecoin in circulation. The issuing corporation offers users a dollar deposit for the same number of tokens.
On the other hand, users can always exchange their tokens for dollars. Due to the possibility of buying and profitably redeeming tokens that trade for less than $1, this convertibility contributes to the stablecoin’s stability. The issuer backstops the token with the value it has gained, acting as the “buyer of last resort”. However, this concept is very centralized because it depends on the banking system and an issuing corporation.
The goal of algorithmic stablecoins is to offer a decentralized method that uses various outside-of-the-chain and within-the-chain processes to follow the dollar. They can employ a fractional reserve model, or other assets might not back them. It is very dangerous to invest in algorithmic coins, and some well-known ones have failed (most recently being Terra). None have shown themselves sufficiently reliable and steady to be widely accepted thus far.
Using an algorithm, or smart contracts, that automatically executes to modify the circulating supply based on market conditions is the third and last way to keep a stablecoin’s peg intact. When the value of algorithmically-backed cryptocurrency declines, the smart contract limit limits the cryptocurrency amount in circulation. The smart contract raises the amount in circulation to maintain price stability when a price starts to stray above the peg.
Commodity-backed stablecoins, instead of algorithmic stablecoins, are backed by variable assets, such as precious metals. Gold is the most often utilized asset to support these stablecoins. A few stablecoin issuers, such as Daxos Gold and Kitco Gold, plan to cash out their currencies using gold bars.
Stablecoins, however, are sometimes backed by assets like real estate, petroleum, or other precious metals. The asset being protected is frequently kept in a vault owned by a reliable third party. A buyer of stablecoins is entitled to exchange the coin for a good or service.
Crypto-collateralization, a method by which assets of other cryptocurrencies back stablecoins, is another comparable technique for preserving a stablecoin’s price peg. Crypto-backed stablecoins are typically overcollateralized because cryptocurrencies are much more volatile than fiat money.
For example, MakerDAO’s Dai (DAI) stablecoin is collateralized at 150%, which means that for every DAI in circulation, there is a 1.5x guarantee in Ethereum (ETH) or other cryptocurrencies equal to its comparable value.
Steady coins can be moved to a cryptocurrency wallet or kept on an exchange. In the former case, the platform holds the stablecoin “in custody”; you do not truly own it. You do not become the owner of the stablecoins until you move them from the exchange into a “self-custody” wallet.
Each choice has advantages and disadvantages. Storing stablecoins on an exchange is convenient, particularly if you trade frequently. That carries some risk, though. Exchanges may experience business failure or hacking. Clients frequently have few options because they are not subject to regulations.
For this reason, many stablecoin holders would rather keep their coins in private wallets. These include software-based digital “soft” wallets and “hard” wallet drives, which resemble USB sticks with digital controls.
Below given are the main applications of Stablecoins:
They provide a rapid and simple way to transfer money internationally without going through stringent government rules or significant modifications to banking systems.
Stablecoins allow investors and traders to enter quickly and exit positions while providing a safe place to store their money. Stablecoins function as a hedging tool against market swings in this way.
Compared to fiat currencies prone to inflation and volatile cryptocurrencies, they offer a more dependable and secure means of making payments online and to businesses.
One of the main elements of the DeFi ecosystem is stablecoins. They offer a simple and safe gateway for newbies to engage in loaning, borrowing, cropping, staking, and other decentralized financial activities.
The list of top Stablecoins includes Tether, USDCoin, Binance Dollar, Dail and TrueUSD.
Tether (USDT) was the first stablecoin launched in 2014, which achieved notable success in the cryptocurrency market. Each USDT has a 1:1 backing by $1 in cash or cash equivalents held by the Hong Kong-based issuing corporation, which has variable degrees of convertibility. Based on current statistics, Tether is the most extensively used stablecoin, supported by many exchanges, with a supply of about 104.4 billion USD and heavy daily trading volumes.
On the Ethereum (ETH) blockchain, USD Coin (USDC) is a stablecoin representing tokenized U.S. dollars. It is run by a centre group, founded by Coinbase and Circle.
MakerDAO, a decentralized autonomous organization, or DAO, maintains Dai (DAI), a cryptocurrency on the Ethereum (ETH) network. Dai was one of the first instances of decentralized finance (DeFi) gaining widespread acceptance.
First Digital USD (FDUSD) is a stablecoin with a 1:1 USD backing distributed by FD121 Limited, a separate company based in Hong Kong named First Digital Labs.
By cutting transaction costs and providing faster, more secure transactions, FDUSD provides users with a dependable digital currency that aims to improve the efficiency of financial transactions by decreasing volatility in the cryptocurrency market.
With the help of FDUSD, a programmable stablecoin, financial contracts, financial services, and insurance may be carried out without the need for mediators.
Ethena USDe is a synthetic dollar launched by Ethena Labs in February 2024. It is called Ethena UDSe because it is built on the Ethereum protocol.
USDe is stable, resistant to censorship, and has an unlimited circulating supply. It relies on the 1:1 backing without entirely relying on collateralization, unlike other stablecoins. It can be used for everyday investments because of its less volatile nature.
Stablecoins, like any other asset, also have their own set of pros and cons; these are as follows:
Stablecoins’ primary advantage over fiat currencies is its use of blockchain technology, which enables them to execute international transactions faster and at a lower cost. These currencies are a great means of transnational commerce because of their quick settlement timeframes. Because they function from wallets similarly to conventional cryptocurrencies, they are also user-friendly.
Stablecoins are more reliable currencies that gain from blockchain technology, which is crucial to increasing their acceptance. Because they are backed by fiat money or commodities, they often don’t experience periods of excessive volatility during trading.
Stablecoins have grown in popularity for traders looking to protect themselves against other cryptocurrencies during price dips. With stablecoins, traders may immediately reenter the market once the price stabilizes and rapidly dispose of their digital assets.
Stablecoins introduce a centralised element, especially with the asset backing, even though blockchain technology and cryptocurrencies embrace the idea of decentralisation. It takes a team that leans the operation further toward a centralized structure to guarantee that an equivalent reserve value supports every coin in circulation.
Several stablecoins have lost their reliability from the public and need more transparency. For instance, there has been a lot of public controversy surrounding Tether regarding the company’s reserve levels, which has resulted in penalties and restrictions from the U.S. government. From that moment, they started publishing the report concerning the company’s reserve holdings.
Stablecoins’ potential to break their 1:1 peg against underlying fiat currencies or other reserves is a major structural risk. Having a significant level of faith in the third parties that control and possess the relevant reserve assets is necessary. External audits are required to ensure that the right amounts of collateral are retained, yet this may be time-consuming and costly.
Regulatory risk is one of the main dangers connected to stablecoins. Stablecoins can come under regulatory frameworks because they are frequently tied to fiat money or other assets. Also, legal agencies might classify certain stablecoins as securities, which might lead to legal issues.
The market is one of the main risks connected to stablecoins. Stablecoins may experience changes in the market due to their pegs to other assets. Taking an example of the U.S. Dollar, suppose a stablecoin is linked to the U.S. dollar, and the U.S. dollar sees a significant decrease in value; the stablecoin may also lose value.
If many stablecoin holders might want to exchange their coins for the fundamental asset at once. In that case, the issuer might not have adequate liquidity to match demand, which might cause the stablecoin’s value to decline.
Stablecoin is also a crypto form, but it varies from cryptocurrencies in many aspects. Let’s know which are the factors that distinguish stablecoins from cryptocurrency:
Stablecoins serve more functions than merely as financial contracts. It is the development of established payment methods and unstable cryptocurrencies. Also, it provides economic advantages comparable to those of fiat currencies.
Source:Coingecko
As per the recent statistics shared by Coingecko, it is clear that the market cap for stablecoins has reached $134,896,961,867, where Tether holds the majority of the share. Therefore, it reflects the volatile nature and prominence of Stablecoins, which will continue to grow even more uniformly.
Stablecoins, being stable assets, have the potential to pave the way for the major adoption of digital assets into daily life.
Stablecoins has shown a heavy shift from 2021 to 2023. The stability of stablecoins’ market value highlighted the potential of stablecoins to stay safe in spite of the volatile nature of cryptocurrencies, even as the market went down from $3 trillion to $1 trillion. Leading stablecoins, such as USDC and USDT, maintained their position.
The stablecoin industry’s quick growth and diversity are evidence of the ongoing innovation in the cryptocurrency space. Along with the growth, it is also expected that the government will regulate the Stablecoins as these are just a modified version of money.
Despite their apparent simplicity, stablecoins provide the smooth transfer of steady value, and they are regarded as one of the most important advances in the cryptocurrency space. While stablecoin designs vary widely, all stablecoin methods share the same fundamental information about the linked asset.
We hope you are now well versed with the stablecoins as we explored their working, risks, advantages, disadvantages, and current and future analysis for a thorough understanding and effective learning.
Tether(USDT) is the widely accepted and used stablecoin, dominating 70% of the market capitalization.
Yes, stablecoin is a kind of cryptocurrency; however, it varies in nature and value in the market.
The top 5 stablecoins include Tether, USD Coin, Dai, First Digital USD, and Ethena USDe.
One of the significant benefits of stablecoins is the stability that they provide, unlike cryptocurrency.
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