February 29, 2024

What is Stable Coin ?

A safe and reliable kind of cryptocurrency, stablecoins are becoming a crucial component of the blockchain experience for institutional and individual investors alike.

Due to its volatility and potential for abuse, cryptocurrencies are not recommended for all individuals or businesses that want to own assets denominated in cryptocurrency. 

Let me introduce stablecoins, a new category of digital assets aimed at ensuring security and stability in cryptocurrencies and decentralised finance.

Stablecoins have made headlines in the mainstream for a variety of reasons over the years. PayPal USD (PYUSD) is the stablecoin that PayPal has recently introduced.

We also have seen  BlackRock’s CEO, Larry Fink partnering with  Circle, the company behind USDC, one of the most popular Stablecoins. Though there are cases of negative press for stablecoins such as USDC depegging its value that are important to know of when learning about this type of cryptocurrency.

In this guide, we'll answer the fundamental question, "What are stablecoins?" and give you a clear understanding of why they are such a dominant force in the world of cryptocurrencies.

What Are stablecoins ?

A distinct kind of cryptocurrency known as a stablecoin seeks to keep its value steady by linking it to a reserve asset. Stablecoins, in contrast to erratic cryptocurrency prices like Bitcoin or Ethereum, are intended to have a constant value.

In this blog, we'll discuss various stablecoin kinds in more detail, but first, to set the scene, one of the most well-known stablecoins is USDT. This cryptocurrency is based on the US dollar in order to preserve its value and stability.

Tether Limited Inc., which created their first stablecoin in 2014, is the brains behind USDT. USDT's popularity was demonstrated by the ten various protocols and blockchains that made it available by 2022.

Stablecoins serve as a compromise for both institutional and individual investors when using the blockchain. You store money as a stablecoin to avoid paying extra costs when transferring between cryptocurrency and fiat currencies. Stablecoins allow for fee-free off-chain transactions since they eliminate the need to convert fiat money back into stablecoins before making a payment.

Additionally, it is now simpler to use your stablecoins and other everyday tokens to pay for groceries and other necessities because of the launch of debit and credit cards based on cryptocurrency. 

Important Features of Stablecoins

It is crucial to comprehend the crucial features of stablecoins. You can make the most of them if you do this.

Price stability: They keep a reserve asset, such as the US dollar (USD), gold, or other cryptocurrencies, at a constant price, typically at a 1:1 ratio.

Asset-backed: To guarantee that the value of stablecoins is correlated with something concrete, they are frequently backed by a reserve of physical assets.

Transparency: Users can confirm the reserves that support a reliable stablecoin by using its transparency feature.

Stablecoins have a high level of liquidity, which makes them ideal for trading, making fast money transfers, and buying goods and services.

Types of stablecoins

Stablecoins come in a wide variety, each with special features, workings, and applications.

1. Stablecoins collateralized by fiat:

Because they are backed by fiat money, these stablecoins are among the most reliable kinds out there. Stablecoins have been developed in tandem with an increasing number of fiat currencies (not just the US dollar), demonstrating how beneficial these currencies are becoming to everyone on the planet.

Fiat-collateralized stablecoin examples

The Euro Coin (EURC): The Euro, which is used in many European nations, backs this stablecoin. Like many other stablecoins like USDC, it is offered to us by Circle and is available on Ethereum, Avalanche, and Stellar.

Tether (USDT): TetherUSD is one of the most popular fiat-collateralized stablecoins. It's widely used in crypto trading but has faced scrutiny due to concerns about its reserves transparency.

USD Coin (USDC): Recognised for its emphasis on regulatory compliance and transparency, Circle's USDC is another extensively utilised fiat-collateralized stablecoin.

Stabiloids collateralized by cryptocurrencies:

One kind of stablecoin that aims to keep its value steady is called a crypto-collateralized stablecoin. It is backed or collateralized by other cryptocurrencies.

With the goal of offering the advantages of cryptocurrencies and steady value, these stablecoins can be used for a variety of purposes without experiencing price volatility, including value storage and online transactions. 

Examples of crypto-collateralized stablecoins

Dai (DAI): Dai is a decentralized crypto-collateralized stablecoin that maintains its value through Ethereum collateral. It's governed by a decentralized community and has gained popularity in the decentralized finance (DeFi) space.

sUSD (sUSD): sUSD is backed by a basket of cryptocurrencies, providing stability through a diversified collateral pool.

3. Algorithmic stablecoins:

Algorithmic stablecoins are a type of stablecoin designed to maintain their value through algorithmic mechanisms, without the need for assets like fiat currencies or other cryptocurrencies. 

They use smart contracts and algorithms to automatically adjust their supply in response to changes in demand, aiming to keep their value constant.

Examples of algorithmic stablecoins

Ampleforth (AMPL): Ampleforth is an algorithmic stablecoin that adjusts its supply based on demand, aiming to achieve a stable price over time.

Frax (FRAX): Frax is another algorithmic stablecoin that uses a unique mechanism to maintain stability, combining fractional collateralization with algorithmic adjustments.

4. Commodity backed stablecoins

Commodity-backed stablecoins are a type of cryptocurrency designed to maintain a stable value by being pegged to a specific commodity or a basket of commodities. 

The value of these stablecoins is tied to the price of the underlying commodity, which can be precious metals, agricultural products, or even energy resources. The most common commodity used as a backing for stablecoins is gold, but other commodities like silver and oil can also serve as the collateral.

Examples of commodity backed stablecoins

Tether Gold (XAUT): Tether Gold is a stablecoin issued by Tether, one of the most well-known stablecoin issuers. It is backed by physical gold stored in Swiss vaults. Each XAUT token is equivalent to one troy ounce of gold, providing a stable store of value.

PAX Gold (PAXG): Paxos Standard (PAX) is a stablecoin, and PAX Gold is a specific version of it backed by physical gold. Each PAXG token is backed by one fine troy ounce of a 400 oz London Good Delivery gold bar.

Energy Token Commodity (ENC): Energy Token Commodity is a stablecoin backed by energy resources. It is designed to provide stability by tying its value to a basket of energy commodities, making it unique among commodity-backed stablecoins.

Investors are spoilt for choice when picking out a type of stablecoin. Each has an array to choose from depending on who, why, and how you will use them on the blockchain.

Be sure to always research a stablecoin before choosing one. You can do so by visiting CoinMarketCap, where a complete, comprehensive breakdown of the token is given, along with market statistics to provide a clear picture.

Positives of Stablecoins

Hedging against volatility: Stablecoins provide a haven for crypto investors during periods of extreme volatility.

This is important for many reasons. You may want to stake your crypto but are worried about the value of your returns being affected by market conditions. 

The choice to put your money into a stablecoin offers users more selection in personal finance and business.

 Facilitating transactions: Stablecoins enable quick and low-cost transactions, making them suitable for daily use.

Blockchains like Ethereum are not the most accessible networks for day-to-day transactions. Hefty gas fees hold it back, which can add up if you process numerous payments over time. Therefore, stablecoins are a vital option.

Smart contract integration: Stablecoins can be integrated into smart contracts on blockchain platforms like Ethereum, enabling programmable financial transactions, decentralized finance (DeFi) applications, and more.

Intelligent contracts are pivotal in DeFi applications, which often involve stablecoins. DeFi platforms use smart contracts to automate various financial services, such as lending, borrowing, trading, and yield farming. Stablecoins are used as a stable unit of account in these platforms, and intelligent contracts control the terms and conditions of these financial transactions.

Negatives of Stablecoins

 Centralized risk: Fiat-collateralized stablecoins rely on centralized entities to hold reserves, which can be susceptible to regulatory pressure.

Furthermore, this goes against the ethos of crypto and blockchain technology. For example, centralized entities may have a say in how a stablecoin can be used and distributed. 

- Lack of transparency: Some stablecoins may not provide sufficient trans1 may not provide sufficient transparency regarding their reserves

- Counterparty risk: Users of stablecoins are exposed to the risk that the issuer may be unable to honor the 1:1 peg. Different stablecoin providers will use various financial service providers to ensure their tokens can be backed against a reliable asset. 

For example Tether uses: 

  • Agricultural Bank of China Ltd
  • Bank of China Hong Kong
  • Bank of Communications Co Ltd
  • Industrial and Commercial Bank of China
  • China Merchants Bank
  • China Construction Bank
  • China Everbright Bank Co.

They ensure assets are backed through commercial paper.

Use Cases of Stablecoins

Stablecoins have found different use cases for blockchain developers, investors and traders, making them a go-to for anyone actively using the technology and services. 

1. Trading and Investment:

Traders often use stablecoins to hedge against market volatility and secure profits during price swings.

Stablecoins are a stable base currency for crypto-to-crypto trading pairs on various exchanges.

2. Remittances and cross-border payments:

Stablecoins offer a faster and cheaper alternative to traditional cross-border payment methods. Workers sending remittances to their home countries can benefit from reduced fees and quicker transactions. 

Businesses use the blockchain to facilitate payments both inland and abroad. This makes stablecoins a great option as they have stability in value and require very little knowledge of blockchain, unlike other cryptocurrencies.

3. Decentralized finance (DeFi):

Stablecoins play a pivotal role in DeFi protocols, providing collateral, liquidity, and stable value to various applications like lending, borrowing, and yield farming.

For example, when you visit our exchange, you will notice that we operate our coin listings in conjunction with USDT. This is a trading pair; an example is BTC/USDT. 

You can also stake your stablecoins on DeFi platforms. Staking is a great way to earn passive income on the blockchain, and doing so with a stablecoin adds an extra layer of safety due to it not being volatile in price. 

4. Everyday transactions:

Stablecoins can be used for everyday purchases, much like traditional currencies.

They are becoming increasingly accepted by merchants and businesses, offering an easy transition from fiat to digital currency. Some examples of businesses accepting stablecoins as 

payment include Travala, Amazon (for gift cards) and Alternative Airlines.

Crypto credit and debit cards are becoming popular, with Mastercard and Visa teaming up with different providers to offer a seamless blockchain experience in the real world.

Impact on the Crypto Space

Crypto and blockchain industries are ever expanding and the introduction of new concepts are always welcomed with open arms. Widespread adoption of stablecoins has had a significant impact on the crypto ecosystem. 

Positives:

- Reduced volatility: Stablecoins provide stability and mitigate the fear of extreme price fluctuations, attracting a wider audience of investors and users.

This is an important feature, as many are skeptical about cryptocurrencies and their price volatility making them less likely to invest and engage in them. 

- Increased liquidity: The availability of stablecoins has improved liquidity in the cryptocurrency market, making it easier for traders to enter and exit positions.

It was recorded in May 2022 that stablecoins amounted for 45% of the liquidity in decentralised exchanges showing the dominance that they have. 

- Facilitating growth of DeFi: Stablecoins are the lifeblood of DeFi platforms, enabling various decentralized applications to thrive and providing users with a stable medium of exchange and collateral.

As time progresses more decentralized apps are made on blockchains like Ethereum and Solana. This creates a reliance on onboarding users, which is possible thanks to stablecoins being easily swapped to tokens such as ETH and SOL. 

From there they can be used on decentralized exchanges to be swapped into more niche tokens that may not be available on centralized exchanges. 

Negatives

- Regulatory scrutiny: Stablecoins have faced increased regulatory scrutiny, particularly those backed by fiat currencies. Regulators are concerned about their impact on the financial system and potential risks.

While the crypto industry is still growing, there is still little regulation around stablecoins. As a result, unauthorized bodies can issue stablecoins, using them as liquidity to back their crypto tokens and services on the blockchain. 

- Centralization concerns: Fiat-collateralized stablecoins are centralized to some extent, which goes against the decentralized ethos of cryptocurrencies.

With fiat currencies being printed by banks, which are centralized, this basically means banks have a hand in the enabling of stablecoins which many may see as a threat to the democracy crypto brings forward. 

- Competing interests: The dominance of certain stablecoins, like Tether, has raised concerns about their influence on the broader crypto market.

Tether’s founder has had to come out and back up claims that their stablecoin has a hand in market manipulation stating, “Tether has never engaged in any sort of market or price manipulation. Tether issuances cannot be used to prop up the price of Bitcoin”

The Tragic Story of Terra Luna

If you have watched crypto markets over the last few years, you will undoubtedly hear of Terra Luna. The Singapore-based Terraform Labs set up this cryptocurrency,

and they had a stablecoin called TerraUSD (UST). 

TerraUSD had a sister coin, Luna, which subsequently crashed in price during the 2022 bear market. The value of the stablecoin began to depeg and a lot of speculation began surfacing around the founder, Do Kwon.

Luna was one of the most significant coins then, with many investors flocking to it as the price surged to an all-time high of $119.18 in April 2022 before dropping a month later in May. 

The crypto incentive at the time was not there, and there was a mass sell-off of TerraUSD stablecoin. Luna went down in value significantly as billions got wiped in market capitalization. As a result, Luna's fate was sealed as the price tanked by 99.99% by the end of May because it was pegged against TerraUSD.

Cryptocurrency prices felt the full effect of the Luna crash. By the end of it, coins like Bitcoin and Ethereum were directly impacted, and a total of $300 billion was wiped.

Stablecoins and the Future of Crypto

In a world where the price of cryptocurrencies can change dramatically in minutes, stablecoins offer a reliable anchor. As we've explored, stablecoins are a powerful category of digital assets with various use cases. 

Whether you're a crypto investor looking to hedge against volatility or someone interested in the broader cryptocurrency space, understanding stablecoins is a crucial step toward navigating this exciting financial frontier.

Remember, while stablecoins provide stability, they also come with their own risks and challenges, so it's essential to do your due diligence before diving in.









February 29, 2024
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