What are Stablecoin and why do they matter?

Cryptocurrencies such as Bitcoin and Ethereum offer a number of benefits. However, the one key drawback is that cryptocurrencies’ prices are unpredictable and have a tendency to fluctuate. This makes it hard for everyday people to use. Generally, people expect to be able to know how much their money will be worth a week from now, both for their security and their livelihood.

Cryptocurrency’s unpredictability comes in contrast to the generally stable prices of fiat money such as the U.S dollar, or other assets, such as gold. Values of currencies like the dollar do change gradually over time but the day-to-day changes are often more drastic for cryptocurrencies, where the value jumps up and down regularly.  

A stablecoin is a cryptocurrency that is meant to limit the volatility that investors experience when using crypto. Stablecoins are usually pegged to another asset with a stable value, but they may also be backed by an algorithm, but these are rather uncommon. Stablecoins came up with a way to keep collateral equal to the value they claim their cryptocurrency is pegged to. 

Now, collateral can take several forms when it comes to stablecoins, including fiat money, commodities, and cryptocurrencies. By far the most common form of collateral is fiat money, especially USD and EUR. However, other assets are also used as collateral, including gold and baskets of cryptocurrencies. 

The most popular stablecoins are those that can provide the most stability, thus the most predictable, risk-free asset in the cryptocurrency market. The stablecoins that are the most stable are also the best at keeping their collateral frequently up-to-date while providing a certain level of transparency and market confidence. 

While Bitcoin (BTC) is the largest cryptocurrency in terms of market capitalization, the most popular stablecoin, Tether (USDT), is the largest in terms of trade volume as well as circulating supply. Stablecoins are useful for investors who want to keep their assets in the crypto space. Switching from crypto to fiat currency can be expensive and time consuming. Stablecoin gives investors the best of both worlds – a stable asset within the crypto space with an advantageous transactional speed. 

Tether is the most popular stablecoin on the market boasting the highest trade volume and market capitalization of any other stablecoin. Backed by USD, they are able to keep one of the steadiest stablecoins that is pegged extremely close to its target price of $1.

Tether is also known for its security and smooth integration with crypto to fiat platforms. However, Tether is rather controversial due to their lack of transparency regarding asset reserves. Nonetheless, the market has continued to support them over other stablecoins by huge margins resulting in them dominating the stablecoin market.

USD Coin comes in at a distant second, but is quite popular and becoming more so as the cryptocurrency market matures. It’s also backed by USD and is built on top of the popular Ethereum (ERC20) protocol. USDC is managed by Circle and Coinbase, which are some of the most well-trusted cryptocurrency companies in the world.

Not only is USDC trustworthy based on their managing companies, but they also publish regular reports using results from third-party audits by a top accounting service. All transactions through USDC are fully compliant with US money transmission laws and occur through established financial firms. 

Paxos Standard Token (PAX) is a USD-backed stablecoin that’s fully managed by Paxos Trust Company and regulated by the New York State Department of Financial Services (NYDFS). Similar to most other stablecoins, it is also built on the ERC20 protocol. 

PAX was first issued shortly after major controversy spread that Tether was ‘printing’ Tethers out of thin air back in 2018, which caused a major trust issue within the market. Based on their audited smart contract technology, PAX has a fully decentralized accounting solution to their stablecoin making it quite revolutionary. They are also regularly audited by several accounting firms, so their reserves are constantly being verified.

Binance USD is a revolutionary collateralized stablecoin tied to the U.S. dollar at a 1:1 ratio. Similar to other stablecoins, BUSD was create to provide ease of transaction over decentralized finance (DeFi) ecosystems. The coin was one of three stablecoin to receive regulatory approval from the New York State Department of Financial Services (NYDFS). It is easy to buy and trade it over several platforms in the U.S. BUSD is built on the ERC-20 protocol in order to reach more platforms. It is stored across several Paxos reserves globally. 

BUSD is the brainchild of Binance and Paxos. BUSD met positive reception from the community once debut and soon expanded its trade to 48 different USD pairs. Since its launch, the token has performed remarkably well, maintaining its intended 1:1 ratio with the U.S.dollar. Withum, an accounting firm that performs the audits and displays them on the NYDFS website in compliance with the NYDFS regulation framework, conducts an audit for BUSD every month.

MakerDAO (DAI) is a very popular stablecoin because while one DAI equals $1, the assets backing that value is a basket of select cryptocurrencies. DAI was also created in response to the Tether controversies and has built a stablecoin that is 100% decentralized and trustworthy. 

One of the unique characteristics of DAI, apart from being a cryptocurrency-backed stablecoin, is that it is always over-collateralized. This means that instead of having a 1-to-1 ratio with the underlying assets, the ratio is slightly greater resulting in having more reserves that is necessary. In technical terms, this results in what is known as a collateralized debt position (CDP), which allows them to keep their reserves safe when their basket of cryptocurrencies enters a volatile period.

Like any form of crypto, stablecoins come with a unique set of advantages and disadvantages.

1. Borderless.

• Stablecoins retain the power of all cryptocurrencies to move without regard to physical borders.

2. Transactional Speed

• Financial transactions on blockchain are objectively faster than traditional processes. Stablecoin transactions don’t have to wait on a 3rd party to verify the transfer, which means no one pays fees to any 3rd party either.

3. Transparency

• Transactions using stablecoins are recorded on a public ledger that can be monitored by anyone, unlike fiat currency.

1. Centralization

• Unlike some cryptocurrencies, stablecoins are mostly created by centralized organizations that own the currency. Even DAI, a well-respected stablecoin that markets itself as decentralized, has faced scrutiny for centralized organization

2. Requires 3rd party audits

• Stablecoins must be audited through 3rd parties that may create conflicts of interest to a decentralized, trustless or pseudonymous experience.

3. Less growth

• Stablecoins don’t provide the potential for high ROIs to investors like unpegged cryptocurrencies.

Stablecoins come in all shapes and sizes, but they all serve a single purpose – to provide stability. By providing stability in the cryptocurrency market, they have effectively invited those market participants who were once too shaky to enter the market due to excessive volatility. It is also given investors, traders, and exchanges opportunities to have a ‘risk-off’ allocation within their cryptocurrency portfolio.

While there are already a number of popular stablecoins on the market, there are likely more to come that serve specific purposes for target users. Stablecoins also bring about the idea of backing cryptocurrencies to all kinds of assets. In this sense, stablecoins are really just a way to accurately price an asset through a decentralized marketplace, which may be the most efficient and trustworthy way to value any assets. That’s one powerful idea and shows a possible path stablecoins may take from today onwards.