The effectiveness of cryptocurrencies has long been discussed and debated. Still, they are emerging to light as effective tools that can be useful and accessible to more than die-hard connoisseurs.
Cryptocurrencies have the power to enable economic and social growth throughout the world, including developing countries. In addition, they offer easier access to financial and capital services.
Surprising, in the last few years, the world has witnessed cryptocurrencies interfering with the traditional financial system.
Crypto tokens are even considered as alternative assets to metals such as gold. One of the prime benefits of cryptocurrency is that it can be traded and considered a separate class for investment purposes. This is also the case with Stablecoins.
Cryptocurrencies have a long way to reach mainstream adoption since one of the well-known drawbacks is their volatility.
The graph below shows the popularity of cryptocurrency across the globe.
Stablecoins were introduced to put an end to this problem. So, if you are pondering the question, what is a Stablecoin, and how are they better than cryptocurrencies? Let us take a closer look.
In the modern-day world, there are numerous currencies across the globe recognised by the United Nations. This includes European Euro to Indian Rupees and more.
These currencies can be used to buy goods and services. Therefore, irrespective of fluctuating exchange rates, inflation or other factors, their value will be subjected to minimal change daily.
This is the prime reason why several economies trust and rely on government-issued currencies.
On the other hand, the value of cryptocurrencies rapidly fluctuates on a day to day basis. As a result, investors will make a colossal fortune overnight, only to lose much of their wealth in a matter of days.
Stable coins were invented to put an end to this problem.
Just like the name suggests, stablecoins have a unique feature of price stability. Their value doesn’t experience fluctuations like cryptocurrencies.
Several stablecoins are pegged at a 1:1 ratio with certain fiat currencies such as Euro or USD, which can be traded on exchanges. Other stablecoins can be pegged to other assets, such as precious metals like gold or other cryptocurrencies.
Stablecoins are a unique blend of the traditional banking system and blockchain. They were introduced to reap both the benefits of price stability and cryptocurrency.
At present, stablecoins occupy a market cap of US$75.3 billion. This is roughly 3.77% of the total cryptocurrency market cap.
If you compare stablecoins with other cryptocurrencies, Stablecoins will undoubtedly have the upper hand. Although both are related to each other, there are some fundamental differences between the two.
- Cryptocurrencies are highly volatile. On the other hand, Stablecoins are free from this issue as they can be pegged by fiat currency, cryptocurrency or any tangible decentralised asset.
- Stable coins can be used as an alternative for fiat currency, while cryptocurrencies hold a significant risk to the investor.
- Many times, cryptocurrencies fail to comply with the rules and regulations directed by the government, Stablecoins being digital tokens of money, are regulation friendly.
- Cryptocurrencies don’t have wider public acceptance, while the general public accepts stable coins more.
- Traders have to wait for the right time to exchange cryptocurrency, while stablecoins can be exchanged anytime due to their price stability.
Stablecoins hold a promising future for all investors. In 2020, the supply of stablecoins exploded after a gap of 5 years to reach 6 billion.
Surprisingly the number almost doubled from 6 billion to 12 billion within four months.
The sudden upsurge in demand for stablecoins is mainly due to the price stability linked with collateral reserves.
Stablecoins are used on Defi platforms which earn a high interest for lending or borrowing the Stablecoins.
Defi platforms work with distributed ledger technology(DLT) such as blockchain.
Since it does not have any intermediaries between the parties of a transaction, the entire currency regulation for all stakeholders is decentralised.
Stablecoins are best suited to satisfy the need for a payment system where the transactions can be done without delay.
As the governments are more supportive of CBCDs( central bank digital currency), soon you could see state-issued collateralised Stablecoins within the near future. However, as the government holds the full right over those coins, ideally, it is preferable to opt for crypto-backed Stablecoin that are decentralised.
Even though the first decentralised cryptocurrencies such as Etherum and Bitcoins struggle to gain market acceptance, Stablecoins have a better chance of being embraced by the public. Thus, soon, we could see people accepting Stablecoins as digital counterparts of fiat currency.
Here are some of the interesting statistics to note.
- In 2020,stablecoin supply exploded by more than 1,200%.
- The stablecoin supply passed $10 billion for the first time in May 2020 (reported by CoinDesk).
- USDC also joined Tether as the only stablecoins with market capitalisations greater than $1 billion after adding $1.5 billion since the end of June.
- Q3 saw stablecoins grow across multiple blockchains as Tether added support for both Solana and OmiseGo protocols.
But the question of whether Stablecoins will completely replace fiat currency is most unlikely since fiat currencies still eclipse other bitcoin counterparts in the market.
Using stablecoin comes with a multitude of benefits. Let us take a look at the few.
Stablecoins are renowned for their ability to be anonymous. Like cryptocurrencies, stable coins can be sent quickly through the internet without intermediaries, banks, or border regulations.
In countries such as Venezuela, where there is a tight restriction in fund transfer through the traditional banking system, stable coins can be a boon if you wish to transfer money across the borders.
Major credit card companies often charge a considerable amount as their card processing fees.
Companies such as MasterCard, Visa and AmEx charge about two per cent per individual transaction.
The peer-to-peer nature of stable coins and lack of middlemen makes the stable coin transaction a lot cheaper.
Transactions of stable coins are carried on public blockchains. Therefore, the user can view all the transactions through a blockchain explorer, providing the needed transparency that people are looking for.
This is impossible in the case of traditional payment systems.
In addition, the transparency of stable coins is reinforced with regular audits as well.
Since the blockchain works independently of banks or other financial institutions, transactions can be done almost any time in a matter of hours.
Since stable coins are nothing but digital codes, the programmable feature can be added to adapt to the changing needs.
This will help to adapt to the user’s changing needs. One of the popular ways to implement this is by building branded stable coins into loyalty programs or rewards.
Loyalty can be integrated into the user experience by building loyalty programs on top of the company’s “branded” stable coin.
This will enable the user to check their loyalty reward and balances within a single app.
Similar to other cryptocurrencies, stable coins are also powered by distributed ledger technology.
The DLT infrastructure enables the reliable and secure functioning of digital databases.
Since the database is decentralised, there is no need for a central authority to constantly check against manipulation.
This technology enables simultaneous updating and validation of information across the network spread over multiple jurisdictions.
DLT plays a significant role in reducing the risk, providing more liquidity to the market and offering convenience in accessing and settling payments globally.
Stable coins can be broadly classified into four. They are
Backed up by fiat currencies such as USD, EUR or GBP, these are the most common types of Stablecoins. Fiat collateralised Stablecoins were the first and most popular types of stable coins.
These stablecoins are backed at a 1:1 ratio. This means one stablecoin is equal to 1 unit of currency it is linked to (like a Euro). Thus, in short, for each stablecoin that exists, there is real fiat currency(theoretically) being held in a bank account to back it up.
If anyone who possesses these coins wants to redeem cash, the entity that manages the stablecoin will take out the amount of fiat currency from their reserve and transfer it to the person’s bank account. In addition, the equivalent stable coins will be either taken out of circulation or destroyed.
As the name suggests, these coins are backed up by decentralised crypto assets such as Ethereum, Bitcoin, etc.
This allows the coins to be much more decentralised than their fiat-backed counterparts. In addition, Crypto backed stable coins are often over-collateralised so they can absorb price fluctuations in the collateral.
If the value of any digital asset fluctuates, it will impact the stablecoins as well. Unfortunately, crypto-backed stablecoins are the most complex form of stablecoin and have not yet gained much traction.
These coins are often over-collateralised to ensure that it absorbs the fluctuations in price. Say, for example, to get 1000 Euros of stable coins; you need to deposit 2000 Euros worth of Ether. In this case, we can say that the stable coins are now 200% collateralised.
Let’s suppose there was a price drop of 30%. This would still help ensure that 1000 Euros worth of stablecoins is collateralised by 700 Euro worth of Ether.
These are the most complex forms of stable coins. Unlike the others, they have no collateral and rely on algorithms and smart contracts to balance the supply and maintain a stable market value.
Stablecoins have the risk associated with cryptocurrencies, mainly regulatory and cybersecurity risks.
The algorithm needs to respond following the market’s movement and ensure that it doesn’t get manipulated. Algo based stablecoins is also dependent on how the reserves are held and maintained.
Unlike the first two, commodity-backed Stablecoins are backed by interchangeable assets such as precious metals.
The most common commodity to be collateralised is gold — however, there are also stablecoins backed by precious metals, oil, real estate etc.
Some of the commodity-backed stable coins are
- Digix Gold (DGX):1 DGX represents 1 gram of gold.
- SwissRealCoin (SRC)backed by Swiss real estate.
- Tiberius Coin (TCX): backed by seven valuable metals commonly used in technology hardware.
Although stable coins are relatively new in the world cryptocurrencies, it offers immense benefits to the investors as it offers both the benefits of cryptocurrency and fiat money.
Being collateral, you don’t have to worry about price volatility as other forms of cryptocurrency.
Market researchers have predicted that soon stable coins will be the best alternative for those who would like to enjoy the stability of controlled currencies and the benefits of fiat money.