The cryptocurrency market is characterized by tremendous volatility. Constant fluctuations in the value of digital currencies make some people afraid of high risk decide not to enter the crypto world. However, this is set to change with stablecoins – stable cryptocurrencies without speculation.
What are stablecoins?
Let’s start by defining what stablecoins discussed in this article are. They are cryptocurrencies whose value remains stable against an established internal asset class. Most often, stablecoins are tied to a fiat currency backed by the government and central banks.
Stablecoins represent an interesting attempt to bring two worlds together – the world of crypto and banking. They take the best from both – low cost and speed from the cryptocurrency world and stability from the traditional finance market.
The idea of stablecoin was first introduced in 2012 in Mastercoin documentation. Two years later, in 2014, BitUSD – considered the first stablecoin – was issued. This currency mirrored the 1:1 dollar exchange rate and was backed by the BitShares (BTS) cryptocurrency.
What role do stablecoins play in the cryptocurrency market?
Stable digital currencies are not susceptible to the speculation inherent in other cryptocurrencies, making them a tempting option for investors worried about the risks associated with exchange rate fluctuations.
When making cryptocurrency transactions, it is unnecessary to exit to a fiat currency – simply switching to stablecoin is sufficient. Stable digital currencies can also act as substitutes for traditional means of payment. In addition, they work great primarily for bypassing unfavorable regulations introduced in some countries.
Stablecoins and their uses
The supply of Bitcoin, not tied to any real or digital asset, is limited to 21 million units. This makes how much Bitcoin costs primarily influenced by the law of supply and demand. Because of this, cryptocurrencies – Bitcoin and beyond – are subject to constant fluctuations. Meanwhile, stablecoins are characterized by relative price stability. Because of this, buyers and sellers can be sure that the value of their assets will not change in a short period.
In the case of dynamic fluctuations in the price of cryptocurrencies, traders can quickly “exit” the exchange, taking out their profits in stablecoin. Stablecoins are an excellent option for traders for whom the high risk of losing their funds is not acceptable. For them, stablecoins are nothing more than a safety umbrella, protecting the profit earned by classic cryptocurrencies.
If the value of stablecoins corresponds to a dollar (or any other fiat currency), then why use them? Trading digital currencies for dollars is associated with higher transaction fees and longer waiting times for processing operations. Therefore, using stablecoins makes it possible to trade cheaper and faster. Besides, stablecoins can be sold on crypto exchanges that do not accept dollars.
Stablecoins vs other cryptocurrencies – differences and similarities
Stablecoins differ from traditional digital currencies, such as the most popular among them Bitcoin and Ethereum. First of all, unlike other cryptocurrencies, stablecoins do not exhibit speculative nature – their price, instead of decreasing or increasing, remains relatively unchanged. This is due to the hedges of the stability of the value of the assets – we will look at the different types of them later in the article. Besides, stable cryptocurrencies are subject to greater centralization and more robust control.
Despite the significant differences, it is impossible not to mention the similarities between stablecoins and cryptocurrencies. Both are based on blockchain technology, ensuring transparency and security of transactions. In addition, stablecoins, like other digital currencies, can be stored in a dedicated wallet.
Types of stablecoin security
The primary division of stablecoins is related to how their exchange rate stability is secured. In this respect, we can distinguish four types of stablecoins:
- fiat-backed: backed by fiat currencies, primarily the US dollar and the euro. Examples of stablecoins of this type are Tether (USDT), Binance Coin (BCN) and USD Coin (USDC);
- commodity-backed: backed by authentic goods, such as gold, silver or oil. Gold Secured Currency (GSX) and Digix (DGX) are examples of stablecoins in this category;
- cryptocurrency-backed: backed by other cryptocurrencies, especially Bitcoin and Ethereum. Examples of stablecoins backed by crypto include DAI and EOSDT;
- non-asset-backed: these stablecoins, instead of being backed by real or digital assets, use algorithms and smart contracts to maintain price stability. Example – DefiDollar (DFD).
What does the future hold for stablecoins? Everything points to their further development – in proportion to the growth of the cryptocurrency market.
Exchanging a digital currency for stablecoin also avoids the tax burden. This is why many people investing in cryptocurrencies transfer their capital to stablecoins instead of fiat currencies, where you have to pay tax.