In recent years, the cryptocurrency market has grown at an exponential rate. With this development came the emergence of the stablecoin market, which now serves as the primary method for users to gain access to the cryptocurrency supply. Indeed, stablecoins like USD Coin (USDC), Tether (USDT), and Paxos Standard (PAX), which make up the top three coins in the industry, are often traded beneath the hundreds of millions of dollars in daily crypto trading.
Stablecoins provide legitimacy to an increasing and important use-case for blockchain technology as a way to implement monetary policies within a growing ecosystem in their native form.
Stablecoins
When viewed in light of current central banking norms, the concept of a stablecoin isn't entirely new, and numerous models have emerged over time in an effort to deliver similar value propositions. A stablecoin's primary goal is to preserve market stability in comparison to other cryptocurrencies including Bitcoin, Ethereum, and Litecoin. The aim of a stablecoin like USDC is to maintain a one-to-one (1:1) valuation with the US Dollar in many cases. In layman's terms, one USDC is equivalent to one Dollar.
What is the Purpose of Stablecoins?
A fiat-pegged stablecoin serves as a link between old and new money models, preserving fiat currencies' supposed security while facilitating access to cryptocurrency markets and blockchain services. Because of the 1:1 ratio guarantee, stablecoins also enable consumers who are wary of highly volatile markets to dip their toes into the space with relative safety and protection.
The Applications of Stablecoins
Cash collection
Remittances for everyday usage
Expenses, salaries, and other regular payments
Trading in derivatives serves
A store of value for long-term hedging.
A stablecoin is a blockchain-based solution that aims to keep crypto values stable in conventional fiat currencies such as the US Dollar and the Euro. As a result, it's not shocking that the sub-market sector's capitalization has risen to $10.5 billion as of this writing.
Stablecoins 101
Bitcoin is already the most widely used cryptocurrency, and there's little reason to believe it would shift anytime soon. Bitcoin rose from about $5,950 in November 2017 to over $19,700 in December, only to fall by nearly two-thirds to $6,900 by early February. Similarly, the big Bitcoin correction on March 12th served as a reminder of the cryptocurrency's inherent volatility. Bitcoin began trading at $8,000 on that day, only to fall to $4,500 by the end of the day, a 43 percent drop. Also intraday price fluctuations can be wild, as Bitcoin veterans can tell you. In reality, it's not uncommon for Bitcoin to move more than 10% in either direction in a matter of hours or minutes.
Although conventional assets such as crude oil, which recently entered negative territory for the first time in history, may now be said in the same way, this kind of short-term uncertainty highlights the need for a reliable commodity to calculate Bitcoin's movements. Essentially, a matured currency should ultimately serve as both a medium of monetary exchange and a means of storing monetary value – both of which should remain relatively constant over longer time horizons by definition.
Since stablecoins are designed to imitate fiat currencies within the cryptocurrency system, the ideal crypto token will retain its buying power with a 2% inflation rate, which would enable users to spend the tokens in the same way they would fiat currencies. People would save or hoard the currency otherwise, as they do with Bitcoin.
Price Stability: Why Is It So?
The key reasons for fiat currency price stability are the reserves that back them and the prompt market steps taken by authorities such as central banks to ensure that this remains the case. Although it's debatable the hard assets back fiat currencies now that fiat has moved from a "gold standard" to a "US-Dollar standard," fiat currencies like the US Dollar are pegged to a basket of underlying assets like forex reserves and hard assets like gold, which act as leverage and keep the price from swinging too much. They do, however, have the full support of the American economy and government.
In certain situations, such as the current crisis, central bankers intervene to balance currency demand and supply in order to keep prices stable. This is often accomplished using a variety of methods, including interest rate adjustments and an increase in the global money supply. Many cryptocurrencies, such as Bitcoin, lack fiat currency features because they are designed to succeed by the sweat of their own brow. Stablecoins, on the other hand, serve as the de facto blockchain-based solution, with direct fiat and other assets serving as collateral.
Because of the fundamental differences in technology, finite supply, and immutable underlying code, cryptocurrencies like Bitcoin were never intended to act as fiat currencies or stablecoins. This opens the door to the closest thing to a free market one might hope for.
What Are the Different Stablecoin Types?
Stablecoins are critical to the burgeoning digital economy because they act as a bridge between different cryptocurrencies and conventional fiat currencies. Stablecoins are divided into three categories.
Stablecoins with Fiat Collateral
This form of stablecoin uses fiat currency reserves, such as the US dollar, as collateral to issue a large number of tokens. Precious metals like gold and silver, as well as commodities like oil, may be used as leverage. The majority of fiat-collateralized US Dollar stablecoins, on the other hand, use dollar reserves.
They are held by third-party custodians and are routinely audited by central banks for regulatory enforcement. Tether (USDT) and USDC are common stablecoins that are backed by dollar deposits and have the value of a single US dollar. However, the reserves of these stablecoins differ: USDT is backed by a basket of different reserves and assets, while USDC is backed by a single USD kept in a bank account.
Stablecoins with Crypto-Collateral
Other cryptocurrencies back this kind of stablecoin. However, such stablecoins are "over-collateralized" since the reserve cryptocurrency might be subject to high volatility. This ensures that a significant portion of the released supply is held in reserve in order to distribute a smaller amount of stablecoins, allowing issuers to preserve price stability.
For example, $2,000 in ether could be kept as reserves for issuing $1,000 in crypto-backed stablecoins, allowing for up to 50% of reserve currency swings (ether). The frequency of audits also contributes to price stability because investors can rest assured that processes are running smoothly. MakerDAO's Ethereum-based DAI employs this scheme, in which the stablecoin 'DAI' is pegged to the US Dollar and a basket of crypto-assets can be used as a reserve.
Stablecoins with no collateral (seigniorage)
This stablecoin is not backed by any reserves and relies on algorithmic processes to maintain market stability. Similar to how a central bank prints and destroys currency, seigniorage-style coins use an algorithmic approach to extend and contract the money supply. The main goal, like that of other stablecoin rivals, is to keep the price as close to $1 USD as possible. However, due to their difficulty and late entry into the market, these are the least common stablecoins.
The future for stablecoins
Stablecoins are becoming increasingly important in the cryptocurrency world. In their position as a viable hedging mechanism for a variety of financial items, they encourage further mass adoption. Given their youth, there is no doubt that there is still a lot of space for innovation and creation. The concrete use-cases for stablecoins allow for a backbone infrastructure that acts as a bridge between old and new financial structures, demonstrating their importance in a burgeoning ecosystem.