what are stablecoins?

A Stablecoin is a type of cryptocurrency whose value is linked to other assets such as fiats or precious metals. They are linked to other assets to have a more stable price. Cryptocurrencies such as bitcoin or Ethereum have many benefits. Everyone around the world can use them as payments, and there is no need for financial institutions to facilitate the transactions. Although they may seem perfect at first, they have their own drawbacks. The value of cryptocurrencies is not stable, and sometimes, they tend to fluctuate drastically. That’s why using them for everyday payments is not ideal. You need to know the value of your money to plan everything in your life.

Other common assets such as fiats or precious metals also face some fluctuations. However, these changes are nothing compared to cryptocurrencies fluctuations. That’s why they are suitable for everyday use. You also don’t need to worry about the value of your fiat currencies falling significantly overnight.

In the following, you can see the fluctuation of bitcoin and the U.S. dollar against the Canadian dollar in years.

Different types of stablecoins

Stablecoins are created in response to the high volatility of cryptocurrencies. They tie the value of cryptocurrencies to some stable assets to reduce these price fluctuations. Usually, people consider fiats as stable assets. Fiats are the currencies that governments issue, such as the dollar or euro. The stablecoin issuers need to provide and store a valuable asset to support the stablecoin. These reserved assets work as collateral to support the stablecoins. There are three stablecoins based on their collaterals:

Fiat collateralized stablecoin

Fiat currencies back this type. These centralized stablecoins are issued at a 1:1 ratio for the underlying asset. Tether (USDT) is considered one of the most famous fiat collateralized stablecoins. Each tether is backed by one U.S. dollar.

Crypto collateralized stablecoin

As its name implies, these stablecoins use cryptocurrencies as collateral. However, cryptocurrencies are not stable, as we mentioned earlier. That’s why these stablecoins use some protocols to stabilize their value. To stabilize the value of these stablecoins high amounts of cryptocurrencies are used as collateral. For example, a company uses two-million-dollar worth of Ethereum as collateral to issue one million stablecoins. Then the company issues them with the value of one dollar per coin. Now, even if the price of Ethereum drops by 20%, the value of the reserved Ethereums is still more than enough to support the one-dollar value of each coin. MakerDAO is one of the most well-known stablecoins in this category.

non-collateralized stablecoin

These stablecoins are not supported by any assets. Therefore, they have no collateral, and they work just like fiat currencies. It means that a central bank issues them. The U.S. Dollar is not collateralized by any asset since the collapse of the Berton Woods Agreement in 1973. It has been constantly managed by the federal reserve. Based on this system, the central bank issues some coins in response to increasing demand and value. Also, it repurchases the coins when the demand level decreases. With this method and using supply and demand rules, a central bank can easily stabilize the price of these stablecoins. Carbon is one of the most famous stablecoins in this category.

Pros and Cons of stablecoins

If you want to use stablecoins for any purpose, you must be aware of their features.

Pros

• Fast and reliable transactions
• Low-cost transactions
• Being stable
• Using blockchain technology, which provides security and transparency
• Using smart contracts to protect both trading parties

Cons

• Centralization
• Low returns and profits (for some stablecoins)
• not many people them

Investing in stablecoins

Stablecoins are gaining much attention in financial markets these days. Many traders use them to profit, and some just use them as a daily payment method. The stablecoins face fluctuations like other cryptocurrencies but as we mentioned earlier, they are not very significant. However, these small fluctuations can still provide the opportunity for traders to trade them.

Investing in the stablecoins backed by gold or currencies is similar to investing in gold or currencies themselves. For example, if the value of gold increases, the gold-backed stablecoin will increase as a result. You can consider it as a different way to get exposure to gold or any other asset.  

Some investors lend their stablecoins to borrowers and receive interest. The rate of return is about 5% to 12% annually, and yield is paid out in the coin they lent out. For example, if they lend tether, they will receive their yield in the tether.

Conclusion

Cryptocurrencies and stablecoins are still very young, and they have not reached their maximum potential yet. Many large companies are trying to create their own cryptocurrencies, and since they have significant supporting capital, we can consider their cryptocurrencies as the new stablecoins. Today some people use them for daily uses. Maybe in the future and after the issuance of better stablecoins more people use them instead of fiats, and the world’s monetary systems will change forever.

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