The popularization of cryptocurrencies has been constant in recent years, but their use and mass adoption run into a frequent problem: the extremely high volatility of assets. It was to get around this issue that stablecoins emerged .
As the name says, stablecoins are currencies whose value is stable , that is, they are assets with very low volatility. This gives cryptocurrency owners the opportunity to exchange assets such as bitcoin , whose value can change abruptly in a very short time, for others whose value is and always will always be the same.
This is very useful for investors to protect themselves in times of high volatility, but also for transactions involving the purchase and sale of goods and services, without the risk that the asset used will drastically change its value in the middle of the transaction.
There are several stablecoins in circulation today, backed by different assets and used for different purposes. Keep reading and know everything about the subject!
What are Stablecoins?
As it is a new market and, compared to “traditional” assets, it is still small, the cryptocurrency market suffers from a known obstacle: the high volatility in asset prices.
This situation makes its adoption and use by the general public difficult, although for bold investors, high volatility can be an attraction. It was to solve this problem that stablecoins appeared .
The idea is that anyone who has cryptocurrencies in their possession can quickly exchange them for digital assets whose prices are virtually unchanged.
This is because stablecoins are backed by real, concrete assets, such as gold, oil or national fiat currencies (euro, dollar, etc.). Therefore, they represent – and always will represent – their real value.
For example, the Tether cryptocurrency (USDT), which is one of the main stablecoins in circulation and is pegged to the US dollar. Thus, 1 USDT will always be worth $1. Despite not having a link with the Fed (the US central bank), it has become a kind of “digital dollar”.
The popularization of stablecoins was fast and accentuated, which caught the attention of several governments around the planet. And that started the movement of creating CBDCs, or “Central Bank Digital Currencies” , which are nothing more than stablecoins issued by central banks.
All CBDCs are stablecoins , as they are stable and linked to “real” assets, but not every stablecoin is a CBDC , as they are not always created or issued by central banks.
What are the main stablecoins?
There are hundreds of stablecoins in circulation today.
Based on market capitalization, the main one is Tether (USDT), pegged to the US dollar. Then come USD Coin, Dai, Binance USD, TrueUSD, Paxos Standard, among many others.
Nine of the top ten stablecoins in circulation are dollar-backed, but there are currencies backed by a variety of other assets, such as gold, commodities and more. The Venezuelan government, for example, announced in 2019 the creation of a stablecoin backed by the country’s oil reserves.
For a stablecoin to survive and fulfill its role, it is essential that the foundation, entity or parent company has a backing equivalent to the total number of coins in circulation, or it will face an enormous risk of insolvency.
Therefore, it is important to know how these assets work before purchasing them, to avoid falling into scams or exposing yourself to unwanted risks.
Currently, there are 4 types of stablecoins :
- Centralized stablecoins: Also called IOU (“I owe you”), this type of stablecoin has an “owner”. The company generates tokens that generally represent state currencies such as the dollar or euro. This model is controversial, as the creators of stablecoin control its issuance, and it is very difficult to know if the company actually has equivalent reserves between stablecoin and the asset it represents. Thus, it is necessary to trust the digital currency issuer. The main stablecoin of this model is Tether (USDT).
- Crypto-collateralized stablecoins: Unlike IOUs, this type of stablecoin uses a decentralized collateral/ballast, which can be the solution to the issue regarding trust in the issuer. In general, these stablecoins are backed by decentralized cryptocurrencies such as Ether (ETH). On the other hand, as they are backed by assets that are highly volatile, these stablecoins may not be that stable, and may suffer occasional price fluctuations. One of the main stablecoins that uses this model is Dai (DAI).
- Commodity-Collateralized Stablecoins : Backed by assets such as precious metals, works of art, real estate and the like, these coins are worth the equivalent of the assets they represent. As these assets can change in price, the same will be reflected in stablecoin – which can be good or bad. In general, those who buy this type of stablecoin do it as an investment, not a form of protection.
- Non-collateralized stablecoins : This stablecoin model has no ballast. What keeps the price of digital currency stable are algorithms that control the amount of assets in circulation, making operations of burning or issuing tokens as needed so that the price always remains the same.
The stablecoins gained strength to try to offer the best of both worlds: the digital security and privacy of digital payment of criptomoedas as well as the speed in the processing of transactions, with less instability and volatility of currencies traditional fiduciary.
The relationship between cryptocurrencies and stablecoins
The Bitcoin came up with the purpose of being mainly used as the digital money . However, the world’s first cryptocurrency is rarely used as a medium of exchange in everyday life.
The high volatility and transaction fees paid to network miners make it difficult to use – and therefore it is currently seen more as an investment asset than a bargaining chip.
The stablecoins create connections between the real world and blockchain . Thus, the purpose of stablecoins is to mitigate and resolve the price volatility that has so widely characterized cryptocurrencies, while trying to maintain other Bitcoin features , such as the free flow of capital and resistance to censorship.