The Complete Guide to Stablecoins
8 min read
Table of contents
- Providing security for cryptocurrency traders
- Digital dollar
- Global payment and remittance
- Benefits of Stablecoin to Fintech
- Let's also look at some of the most popular stablecoins.
- Types of Stablecoins
- Crypto-Collateralized Stablecoins
- Commodity-Collateralized Stablecoins
- Non-Collateralized Stablecoins
- Fiat-Collateralized Stablecoins
There are a lot of misunderstandings between Bitcoin and Stablecoin. The latter is more stable in value and less susceptible to market value fluctuations. On the other hand, Bitcoins are highly volatile in market value, which is constantly changing. If you read my DeFi article, you'll know that you'll need a stablecoin to build a DeFi application, not bitcoin.
Bitcoin is one of the most popular cryptocurrencies. Can it be a replacement for fiat currency? I doubt! Bitcoin constantly fluctuates in price, forcing traders to wait for the right moment to exchange their Bitcoins.
Their volatile nature makes them unsuitable for personal and business transactions. The value of a stable coin remains constant at $1.00. However, they might fluctuate in predictable ways.
A single entity controls stablecoins, and the price of stablecoins remains constant, making them non-volatile. They are well suited to commercial transactions. The use of stablecoins is regulated. You can use them to buy and sell things without fear that they might crash right after you get them. Stablecoins can also play an essential role in enabling quick and secure digital payments while maintaining their price value during hard times.
A stablecoins backed by fiat currency is centralized, meaning a single entity manages them. This requires trust in the entity, whereas Bitcoins are decentralized.
Some stablecoins are pegged to the value of commodities such as precious metals, industrial metals, oil, or real estate. Commodity investors appreciate the option of commodity-backed stablecoins because it allows them to invest in gold without worrying about sourcing and storing it. Stablecoins, such as USDT and Tether, is backed by fiat currencies and typically require a custodian to regulate the currency and keep the fiat reserve.
Some stablecoins are decentralized coins, and their value is determined by supply and demand. They are usually not issued by any centralized organization, and the company has no control over their value. They use smart contracts to manage the collateral and keep things running smoothly. An excellent example of a stable coin like this is DAI
Providing security for cryptocurrency traders
Stablecoins also shield traders and investors from market volatility. Traders can protect their investments during a bear market by instantly converting their Bitcoin, Ethereum, or other cryptocurrencies to stablecoin. Traders can also increase their crypto holdings by entering and exiting the market with stablecoins without having to convert them to fiat currency.
The emergence of stablecoins has opened the gate for governments and central banks to explore the possibilities of decentralized technology. A good example is the Central Bank Digital Currency (CBDC), which are digital tokens, similar to cryptocurrency, issued by a central bank. They are pegged to the value of that country's fiat currency. Read more. CBDCs are now being developed and implemented in many countries.
Recently The Bank of England has published a discussion paper to broaden the debate around new forms of digital money and solicit feedback from a wide range of stakeholders on the bank's emerging ideas. Throughout, new forms of digital money are assumed to be stable in value with a retail focus. They are just indicating their efforts towards leveraging digital payments. You can find this report here
For example, eNaira is a Central Bank of Nigeria-issued digital currency that provides a unique form of money denominated in Naira. eNaira serves as both a medium of exchange and a store of value, offering better payment prospects in retail transactions when compared to cash payments.
The e-CNY, also known as the digital yuan and officially called the Digital Currency Electronic Payment (DC/EP), is a digitized version of China's legal currency, the renminbi (RMB). China's central bank issues it, the People's Bank of China (PBOC).
A bill has been introduced in Congress that would allow the US Treasury to create a digital dollar, a virtual representation of the US dollar. This would allow people to pay with tokens on mobile phones or cards rather than cash. Given the technological trends and broader financial and political developments surrounding digital currencies, a digital USD is likely to be implemented.
Global payment and remittance
Banking giant Wells Fargo uses stablecoins as a solution to settle international payments. > Wells Fargo says its blockchain for internal cross-border money transfers is faster and more efficient than SWIFT, the global messaging system used by over 11,000 financial institutions.
"When we move money across the world, and we need to exchange currencies, we have to go through third parties such as SWIFT and other banks," said Lisa Frazier, head of the Innovation Group at Wells Fargo. "That's a long process, and every time there's a connection with external parties, it takes time, energy, and effort."
She told CoinDesk
JPM Coin is a digital coin designed to make immediate payments using blockchain technology.
Benefits of Stablecoin to Fintech
Blockchain-based: Stablecoins, like any other cryptocurrency, use blockchain technology. Security, transparency, and accountability, the core benefits of blockchain, are now available to everyone.
Faster and less expensive remittances: Compared to current financial systems, which are plagued by a slow and costly network and transaction fees. Stablecoins provide a faster, cheaper, and more secure mode of cross-border payments or remittances.
DApps: In the DApp ecosystem, developers can integrate stablecoins with applications and services for in-app purchases and other payments.
Kitco, a Canadian provider of gold and precious metals news and data, has entered the stablecoin market. According to a press release shared with CoinDesk. Kitco Gold (KGLD) will be fully backed by physical gold held in Kitco's Direct Reserve vaults and will track the real-time market value of the yellow metal.
Stablecoins are a very safe long-term investment. Gemini Dollar, Dai, and PAX are the safest stablecoins, according to financial experts. So, if you want to invest in Stablecoins, you can do so in these assets.
Stablecoins do not require a bank account and are easy to transfer worldwide, including in locations where the US dollar is challenging to obtain or unstable local currency. There are simple ways to earn interest on a stablecoin investment typically higher than what a bank would offer. It also enjoys low transaction fees and fast processing.\
Let's also look at some of the most popular stablecoins.
Dai — Dai is a well-known decentralized stablecoin created by Maker DAO, which also governs it. 1 Dai is equivalent to 1 USD. Dai coin is compatible with over 400 apps and services.
USD coin — (USDC) is an Ethereum-based stablecoin. USD coin was launched by the centre consortium, Coinbase, and Circle. Its value is pegged 1:1 with the US dollar, which means holders can redeem 1 USD coin for $1 at any time. Every USDC is backed by one dollar or an asset with an equivalent value, held in accounts with US-regulated financial institutions.
TrueUSD — TrueUSD is an Ethereum-based stablecoin that attempts to maintain a value of $1.00. Banks hold US dollars in escrow as collateral for the supply of TUSD. On the TrustToken website, you can buy and redeem tokens in US dollars. It's one of the most dependable and tested stablecoins on the market.
The Paxos Standard Token — The Paxos Standard Token (PAX) is a stablecoin running on Ethereum. It is one of the most quickly adopted stablecoin and approved by the New York State Department of Financial Services. The company behind the protocol is responsible for holding reserves that fully back each token. It is also backed in a 1:1 ratio by the US dollar. The tokens are destroyed when the coin is redeemed for USD.
Types of Stablecoins
Let us now examine the various types of stablecoins.
Crypto-collateralized stablecoins are those that are backed by other cryptocurrencies. Through over-collateralization, these stablecoins maintain their 1:1 ratio. This structure provides a buffer against price fluctuations caused by the underlying collateral. For instance, DAI, a stablecoin backed by another cryptocurrency developed by MakerDAO. BitUSD is another well-known crypto-collateralized token supported by Bitshares.
Commodity-backed stablecoins are the type of stablecoins that are collateralized using physical assets like precious metals, oil, and real estate. Gold is the most popular commodity to be collateralized; Tether Gold (XAUT) and Paxos Gold (PAXG) are two of the most liquid gold-backed stablecoins.
Another good example is the gold-backed Digix. This means that 1 DGX equals 1 gram of gold on the ETH network. Tiberius is another good one backed by the combination of seven precious metals commonly used in hardware technology.
With this type of stable coin, algorithms instead of assets determine the value of non-collateralized stablecoins. Some good examples are CarbonUSD and kUSD. The tokens rely on a mechanically generated algorithm that can change the supply volume to maintain the token's price, which is pegged to an asset. The system also operates with the help of smart contracts, which helps to sell tokens if the price falls below a predetermined level and supply token to the market if the price rises. This automated process helps the toke remain stable and secure to its peg.
Fiat-collateralized stablecoins are backed by sovereign currency such as the Pound Sterling or the US dollar. This means that to issue a certain number of tokens of a given cryptocurrency, the issuer must provide collateral in dollar reserves worth the same amount. The idea behind this is to support stablecoin with real fiat in real bank accounts. The only problem with this approach is that a centralized authority controls it. The issuing party must trust that they have the appropriate assets to pay out the token.
In summary, stablecoins are just like fiat currency that you can use for mainstream commerce, but with the additional benefits of cryptocurrencies. This can be useful for overseas payment since there will be no conversation about different fiat currencies. It is more like a new form of digital money controlled algorithmically and provides monetary benefits comparable to fiat currencies. Stablecoins have the potential to broaden the mainstream adoption of digital assets in everyday life.