An Introduction to Stablecoins and Why They are Important to Your Portfolio

By cam_elica_24 | CoinFalcon | 5 days ago

$3.02 tipped


Since their inception, cryptocurrencies have been revolutionary in every sense of the word. For many crypto enthusiasts, crypto is the future of money and will finally break us free from the illusion of control that centralized institutions have sewed upon us. Despite all their good qualities and exciting potential, however, there is one thing that has consistently stopped them from mainstream adoption. As a matter of fact, this one thing has been so deeply interwoven in the crypto space, that people even make jokes about it:

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Image source: Ryan Neuner Twitter

That one thing is market volatility. This, in many ways, is the biggest barrier faced by cryptocurrencies, even to this moment. And yet, during the chilly crypto winter of 2018, there was one sector of the cryptocurrency industry that was still booming -- Stablecoins. In this article, we’ll provide a closer insight into Stablecoins and its importance to the crypto space and your investment portfolio. Here at CoinFalcon, we offer one of the most popular Stablecoins on the market today, Tether (USDT) coin, which currently boasts a market capitalization of €4.15B and is ranked in the top 10 cryptocurrencies.

What is a StableCoin?

In simplest terms, a stablecoin is essentially a cryptocurrency that has a built-in price stability mechanism, in contrast to many cryptocurrencies like Bitcoin and Ethereum which are notorious for their volatility. This is done by pegging its price to more stable assets, such as fiat currencies (Dollar, Euro, etc.) and commodities (e.g gold). You can think of a StableCoin as a cryptocurrency with a fixed price that potentially unlocks large benefits for a decentralized Internet by providing stability, scalability, privacy, decentralization, and redeemability.

No longer do you have to worry about the daily fluctuations of crypto assets when deciding to make a purchase. In the short-term, the stability provided by Stablecoins allows people to transact in a practical way, while the long-term stability enables other important financial functions such as loans and credit. That's why several investors believe that the widespread adoption of Stablecoins is the key to unlocking the true potential of the blockchain network.

How Do Stablecoins Work?

The basic concept of a StableCoin is pretty straightforward: it’s a cryptocurrency that’s designed to maintain a stable price, no matter the market conditions. But how do they achieve this? To answer this, let’s take a more in-depth look at the three approaches to developing a price-stable cryptocurrency:

  1. Fiat/Commodity collateralized
  2. Crypto-collateralized
  3. Seignorage shares

Fiat/Commodity collateralized Stablecoins

This implementation is the most tangible and generally involves each unit of the stablecoin being backed by a corresponding unit of fiat currency, like the U.S. dollar. The mechanics here are fairly straightforward -- a third party receives a deposit in dollars and issues a unit of StableCoin to match each dollar deposited. Some of the most common fiat pegged Stablecoins include Tether (USDT), TrueUSD (TUSD), and Trust Token.

Commodity-based stablecoins are just like fiat-pegged stablecoins, in that the commodities are used to guarantee the price of the cryptocurrency. They often use stores of commodities to guarantee the price of the cryptocurrency. As of February 2019, some commodity-based stablecoins like DGX, HelloGold, and OneGram are already available on the market.

Crypto-Collateralized Stablecoins

This approach relies on utilizing cryptocurrency to back the coin as opposed to fiat collateral. In most cases, crypto-collateralized Stablecoins also hold a ratio greater than 1:1 of a cryptocurrency or basket of cryptocurrencies, unlike with fiat currencies were the ratio is pegged at 1:1. The implementation is conducted on-chain using a crypto asset, like ethereum, as collateral. One main benefit here is that it does not require users to trust a third party to conduct transactions; however, there’s always the concern that the underlying collateral may be highly volatile. As such, in order to protect it against significant price drops, a considerable amount of over-collateralization must be held---as much as 2:1 or even greater.

Seignorage Shares Stablecoins

Unlike the other two approaches, this option does not rely on being collateralized by either fiat or cryptocurrency holdings. Instead, a "central bank" is created that algorithmically maintains the supply of currency to maintain the price level. Thus, it increases the supply when the price goes up and decreases it when the price goes down. This approach works by following a rules-based system designed to keep the price of a stablecoin anchored at a particular value.

Price Movements

If the asset were to rise in price, traders would simply purchase it from the issuing organization in exchange for fiat currency. They would then sell the coin onwards for a profit since it has risen in price beyond its peg. Thanks to the principles of supply and demand, the new supply of coins created by traders would cause the price to drop back down to its peg. On the other hand, if the StableCoin were to fall in price, traders would purchase it from the open market, then redeem the coin with the issuing organization, which also generates a profit since it was purchased for less than its peg.

In theory, that’s how most Stablecoins are designed to work, although the exact mechanisms may differ slightly in practice.

Why Do Stablecoins Matter?

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Image Source: Blockdata

The growing popularity of cryptocurrencies revolves around their array of benefits, from decentralization and transparency, to security and convenience, and more. However, market volatility continues to cast a huge shadow of doubt for its general adoption. Stablecoins promise an on-ramp into the crypto world without that pesky market volatility. Users can easily trust and understand it, which in turn paves the way for wider acceptance and adoption of digital money and securities. It’s like a bridge between the traditional and the crypto financial worlds.

With Stablecoins, you can sell your cryptocurrency holdings into USDT if you expect the crypto to go down so as to protect your deposit without moving your money into fiat. It is also helpful for institutional investors looking to enter the crypto market. In this case, they simply deposit their fiat to a bank, receive the corresponding stablecoin value and use it to trade on an exchange.

As you can expect, not everyone agrees with this sentiment. For instance, many pro-Bitcoiners argue against the adoption of fiat-pegged cryptocurrencies since they often need centralized mechanisms and still rely on the government-issued currencies that the Bitcoiners are trying to get away from.

Real-world Applications of Stablecoins

Although still in its early stages, Stablecoins have many potential real-world applications, such as:

  • A day-to-day currency -- You can use Stablecoins just like any other currency for mainstream commerce, but this time with the added benefits of being a digital currency that’s legally backed and secure. This is especially beneficial for overseas payments, since it eliminates the need to convert to different fiat currencies. A person in the Philippines could receive USD-backed stablecoins without converting them into pesos and losing a massive percentage to fees.
  • Streamlining recurring and P2P payments -- Stablecoins allow the use of smart financial contracts that can be enforceable over time. These automatic transactions are transparent and immutable, which makes them ideal for salary and payments, like rents, loans and subscriptions. For instance, an employer can simply set up a smart contract that automatically transfers stablecoins to his employees at the end of each month, or you could set up a smart contract to pay a set amount of Stablecoins to your landlord on the first of each month, without worrying about high fluctuations in price like with non-stable cryptocurrencies.
  • Affordable and fast remittances for migrant workers -- Today, migrant workers send remittances through agencies like Western Union and MoneyGram to their families and loved ones. Aside from the fact this is often a slow and costly process, families also end up losing a big chunk of their funds to high transfer fees. With Stablecoins, migrant workers and their families could simply use digital wallets to transfer remittances from anywhere in the world almost instantly — with low fees, and without price volatility.
  • Protection from local currency crashes -- In the event of a fiat currency crashing in value, citizens of that country could quickly exchange their crashing currency for USD-backed, EUR-backed, or even gold-backed Stablecoins so they don't lose even more of their savings. A good example was the case of the hyperinflation that occurred in Venezuela in which the prices of goods were doubling every few weeks and most Venezuelans were struggling to afford basic necessities like food because their savings had become increasingly worthless. Stablecoins could be a viable solution by allowing people to quickly exchange their dropping currency holdings into a stable currency, thus protecting them from further drops in value.

Looking ahead

Like other cryptocurrencies, Stablecoins are still in their infancy and have a long way to go before potentially reaching maturity. Nevertheless, even though it is impossible to predict what the future has in store in the constantly changing world of blockchain, Stablecoins have the potential to help bring cryptocurrencies as a whole to the mainstream and reduce risks and frictions associated with government regulations. Looking to own some Stablecoins as part of your crypto investment portfolio? Get your Tether(USDT) on CoinFalcon today! We also offer several other cryptocurrencies, such as Ripple, IOTA, Litecoin, Bitcoin Cash, EOS, and GreenPower, among others.

 

 

 

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