A beginner's guide to what are stablecoins in cryptocurrencies? What are the different types of stablecoins and how are they backed to different assets?
After Bitcoin created an industry of cryptocurrency, many new concepts and theories have erupted in the market. The one that has gained prevalence in recent years is the concept of stablecoin. So, what is stablecoin and how is it different from other cryptos in the market?
The concept of cryptocurrency has grown significantly popular due to its foundation on solid theories of blockchain and cryptography. However, digital assets like Bitcoin and altcoins are volatile in nature. Stablecoins provide the advantages of digital currencies along with eliminating the volatile nature.
Volatility in Cryptocurrency
Digital currencies can offer a range of benefits that include instant transfer, negligible fees, and further adds ease and efficiency to financial transactions. The concept itself has not gone unnoticed. Even governments around the globe recognize the value of cryptocurrencies.
However, the industry is yet immature. Its inherent nature of volatility persists even now. The price of one Bitcoin has gone from a few hundred in 2011 to $20,000 in 2017. The value of Bitcoin dropped to $4500 in March 2020 and currently, in April 2021, the price of one Bitcoin currently stands at $60,000. While Bitcoin is rising in its popularity as an investment vehicle, the drastic volatility in its price makes it impossible to use it as a payment method for daily needs like buying a can of milk.
However, the advantages of digital currencies significantly outweigh fiat currency transactions. Stablecoins help retain the value and benefits of crypto along with eliminating its volatile nature.
What is Stablecoin?
Stablecoins, a type of cryptocurrency, have their value pegged (equivalent) to another asset. This asset can be the United States Dollar, another currency or cryptocurrency, precious metals like gold, or a combination of multiple factors.
One of the most favorable options is the United States Dollar and many stablecoins have their underlying asset as USD. Meaning, that 1 stablecoin equals $1. Hence, stablecoins eliminate the volatility in crypto prices while taking advantage of its features like transparency, privacy, and security.
Furthermore, stablecoins are also backed by an underlying asset. In other words, say if there are $100,000 coins in circulation, the subsequent amount should be held in bank reserves.
Advantages of Stablecoins
Stablecoins are going to play a huge role in the widespread adoption of cryptocurrencies. Central governments around the globe are also planning to create centrally backed cryptocurrencies (CBDC’s) which are essentially stablecoins.
Remittances, Banking, and Financial Ecosystem
Margin workers have to encounter heavy transaction fees while sending money back to their hometowns. Besides this, the money takes days or even weeks to reach. Using stablecoins backed by USD or some other currency, allows migrants to instantly send money with almost negligible transaction fees.
Even businesses looking to send or receive international payments can freely do so without incurring heavy fees. In both cases, using a cryptocurrency like bitcoin is a bit risky due to its speculative nature in price.
The stablecoins can add value to unbanked communities like refugees. Using this form of digital currency enables inclusive financial services to those left out of our current ecosystem. Not bound by conditions, stablecoins can render financial relief to the unbanked or unidentified people in the system.
Stablecoins can also be used for simplifying and streamlining P2P payments. For example- a company paying a monthly salary to its employees via stablecoins. This further opens up a number of possibilities and reduces third-party costs.
Types of Stablecoins in 2021
There are 4 main categories of stablecoins.
The most commonly available stablecoin is linked with a fiat reserve (like a dollar). These coins are held in a 1:1 ratio with the selected fiat currency. For each stablecoin that exists in circulation, an equivalent amount is held in a bank account. This category of stablecoin is backed with the equivalent fiat currency.
The most popular stablecoins available in the market today include Tether (USDT). A user can buy or sell Tether (USDT) on XanPool.
Unlike bitcoin, commodity-based stablecoins hold a tangible asset to back their value. The assets can be either gold, real estate property, oil, etc. Creating tokens (stablecoins) that represent a physical asset can open windows to new businesses. Furthermore, stablecoins do not remain bound to geography which increases liquidity, transparency, and efficiency.
Such stablecoins are backed by other cryptocurrencies like bitcoin and ethereum. As the underlying cryptocurrency is highly subjected to volatility, stablecoins are overly collateralized. This means that a high value of the crypto needs to be stored as the ásset’.
Much like fiat currencies, non-collateralized stablecoins are not backed by any underlying asset. Instead, such stablecoins play the role of a central bank which monitors that the price of the stablecoin remains ‘stable’.