A stablecoin is a type of digital currency whose value is anchored to another coin, item, or financial instrument. Stablecoins aims to reduce the high volatility of the foremost popular cryptocurrencies, including Bitcoin (BTC), which has made crypto speculations less reasonable for common exchanges.
Importance of Stablecoin
In spite of the fact that Bitcoin remains the foremost well-known cryptocurrency, it tends to endure high instability in its trade rate. For instance, Bitcoin’s cost rose from $5,000 in March 2020 to over $63,000 in April 2021 only to plunge over 50% in the next two months.During these macro cycles,intraday swings were also wild; the cryptocurrency often moved more than 10% within the span of a few hours.All this volatility can be great for dealers, However, it turns routine exchanges like purchases into risky speculations for the buyer and seller.
Properties of Stablecoins
Stablecoins inherit some of the most useful characteristics of non-pegged cryptocurrencies while being free from their instability.
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- Stablecoins are open, global, and accessible to anybody on the web
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- They’re quick, cheap, and secure to transmit
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- They’re digitally native to the Web and programmable
3 Types of Stablecoins
1. Fiat-Collateralized Stablecoins
2. Crypto-Collateralized Stablecoins
3. Algorithmic Stablecoins
1. Fiat-Collateralized Stablecoins
Fiat-collateralized stablecoins keep up a reserve of fiat currency (or monetary standards) such as the U.S. dollar, as collateral assuring the stablecoin’s value. Other forms of collateral can incorporate valuable metals like gold or silver as well as commodities like crude oil, but most fiat-collateralized stablecoins have reserves of U.S. dollars.
Example: Tether (USDT) and TrueUSD (TUSD) are the most popular stablecoins which are supported by U.S. dollar reserves and denominated at parity to the dollar.
2. Crypto-Collateralized Stablecoins
Crypto-collateralized stablecoins are supported by other cryptocurrencies. The reserve cryptocurrency may also be inclined to high volatility. This suggests that stablecoins are over-collateralized, which means the value of cryptocurrency held in reserves exceeds the value of the stablecoins issued.
To protect against a 50% drop in the price of the reserve cryptocurrency, a cryptocurrency worth $2 million might be kept as a reserve to issue $1 million in a stablecoin backed by cryptocurrency.
For instance, MakerDAO’s Dai (DAI) stablecoin is backed by Ethereum (ETH) and other cryptocurrencies worth 150% of the DAI stablecoin in circulation and pegged to the U.S. dollar.
3. Algorithmic Stablecoins
Algorithmic stablecoins may or may not hold reserve assets. Their essential distinction is their strategic planning of keeping the stablecoin’s value stable by controlling its supply through an algorithm, which is basically a computer program running a preset formula.
In a few ways, they are not so distinctive from central banks, which also do not rely on a reserve asset to keep the value of the issued currency stable.
In contrast, a central bank like the U.S. Government Reserve can freely set financial policy based on well-known parameters, and the legitimacy of that strategy is greatly enhanced by the fact that it is the issuer of legal money.
Example: Magic Internet Money is one of the algorithmic stablecoins issued by several crypto asset exchanges like Uniswap, PancakeSwap, and Curve Finance.
Purpose of Stablecoin
1. Minimise Volatility
An asset that’s pegged to a more steady currency can provide buyers and dealers certainty that the value of their tokens won’t rise or crash erratically within the near future.
2. Trade Assets
You don’t need a bank account to hold stablecoins. Furthermore, they are easy to exchange as well. Stablecoin’s value can be sent effortlessly around the globe, including to places where the U.S. dollar may be difficult to get or where the local currency is unsteady. Stable Coins are best used for buying and selling your crypto. In the past you would generally swap from Bitcoin or Etherium into a different crypto that was equally as volatile. This made selling your crypto extremely difficult and expensive in order to convert it into a fiat currency. Stable Coins have made this much easier. Costs of exchanging out of a crypto currency into a fiat currency have been reduced because the stable coin remains stable and represents the unit value of a fiat currency.
3. International Exchange
Stablecoins like USDC are a good choice when it comes to exchanging currency in a cost-efficient way. Low transaction fees and faster processing make Stablecoin a good alternative for sending money anywhere around the globe.
4. Earn Interest
Stablecoin investment gives you an opportunity to easily earn interests that are higher than what the bank has to offer you. So investing in Stablecoin seems to be a more viable choice.
5. Cost-Efficient Mode
Due to fewer transaction fees, Stablecoins allow you to transfer money easily in a cost-efficient way.
Investing in cryptocurrencies and other Initial Coin Offerings is highly risky and speculative. We know that every individual’s situation is unique and requires a different course of action. In this regard, it is highly recommended to consult a qualified professional before making any financial decision.