Crypto Academy

What is Stablecoin?

What is Stablecoin?

5 min reading

Let’s get acquainted with a stablecoin while reading this article. You’ll find out about its types and role in the cryptographic world.

what's stablecoin

What is Stablecoin?

Stablecoin is a type of digital money that is stable and linked to real assets, such as Fiat (for example, USD, EUR, CNY, or JPY) and sometimes even with gold or oil. They have a fixed rate, which can vary within 1% in each of the parties. Cryptocurrency is not linked to any central bank or institution, instead, such assets rely on their cryptography and strict auditing. With their help, investors and other market participants are able to cope with a number of disadvantages of classic cryptocurrencies, as well as provide the cheap and fast exchange of a stable currency anywhere in the world without limits. This class of digital assets also has low exchange rate volatility. 

Stablecoin offers a steady price, facilitating it for certain functions, such as exchange medium, account unit, and value accumulation. The goal of creating Stablecoin was to integrate new economic innovations into existing businesses without the risk of losing funds. Therefore, Stablecoins can be used for various settlements between two counterparties behind the banking system, providing high security and privacy.

Types of Stablecoins

All currently available Stablecoins can be divided into three types:

    • Stablecoins backed by traditional currencies and other assets. Let’s say you have a certain amount of, for example, dollars, and digital tokens are issued for this amount in a ratio of 1 to 1. The algorithm is simple, reliable, and accessible for everyone. As we have already mentioned, gold, oil, etc. can act as an asset. 
    • Stablecoins backed by other cryptocurrencies. Everything is the same, but instead of fiat currencies and other financial assets, such stablecoins are “pegged” to top cryptocurrencies such as Bitcoin or Ethereum. As you can imagine, the scheme is not secure. Unexpected impact of value, backed by stablecoin, could almost completely devalue cryptocurrency.
    • Stablecoins without collateral. It’s even easier. Such tokens have any price, since they have no connection to anything tangible. 

When it comes to fiat-based stablecoins, a prime example would be Tether (USDT), TrueUSD (TUSD). Also, let’s give an example of the largest commodity-backed stablecoin is DGX, an Erc-20 token backed by physical gold, fully vetted and stored at Safe House vault in Singapore. The most prominent example of a crypto-backed token is MakerDao (DAI). And when it comes to senorrage-style stablecoins, Basis and Havven are good examples.

Pros and cons of Stablecoins

Stablecoin has a number of advantages. The Stablecoin volatility is said to be lower than other cryptocurrencies. Their price directly depends on the exchange rate of the real asset. It turns their tokens into a payment means that can be used for payments in everyday life. In addition, inflation is also possible for such cryptocurrencies. This is an additional incentive to spend them, rather than keep them in the piggy bank. 

The development of the cryptocurrency industry and digital assets can grow in several directions. For example, Stablecoins  enable credit and insurance services to appear on the blockchain due to the small price. It prevents sharp jumps in the conventional cryptocurrencies rate. Furthermore, Stablecoin cannot be affected by the government actions or the Central Bank. Important to note that stablecoins could be useful for countries with a high level of inflation. The phenomenon of stablecoins is characterized by a total stability and security, eliminating the vulnerabilities or brittleness of the system.

The picture would be incomplete if we did not mention the disadvantages inherent in Stablecoin. The first drawback lies in the binding to fiat currencies. For example, if the Stablecoin price depends on the dollar exchange rate, then such tokens become its derivative. Also, the main disadvantage is that intermediaries are required for functioning, which increases the risks of uncontrolled emissions. As a result, decentralization is impossible. 

Stablecoin issuance requires the creation of special companies, responsible for coins provision and guarantee of free exchange. It should be mentioned that stablecoins have a slow withdrawal to fiat and a high degree of regulation. However, this type of digital currency is a powerful tool that can help to improve the cryptocurrency ecosystem as a whole, as well as being an alternative means of saving in cases of high market volatility.