The utility of stablecoins has skyrocketed in recent months, thanks in part to the explosion of innovation in the decentralized finance (DeFi) industry.
Stablecoins are currently used by several million cryptocurrency holders and account for nearly 40% of all cryptocurrency trading, while the number and variety of different stablecoins have grown significantly in recent years – with USD peg, BTC peg, and the variety of synthetic stablecoins that are now widely used.
What Is Stablecoin?
Stablecoin is a type of cryptocurrency. Its value depends directly on external assets such as the US dollar or gold for stabilizing the price.
This makes stablecoins a more convenient form of payment compared to traditional cryptocurrencies.
There are three types of stablecoins, each with its own working mechanism: fiat-collateralized stablecoins, crypto-collateralized stablecoins, and non-collateralized stablecoins.
Types of Stablecoins
- Fiat-collateralized stablecoins
Fiat-backed stablecoins are backed by a sovereign currency like the pound or the US dollar. To issue a certain amount of tokens of a cryptocurrency, the issuer must offer equal dollar reserves as collateral.
Gold can be used for this purpose too. Reserves are often maintained by independent custodians. Their task is to regularly check for compliance.
Cryptocurrencies backed by dollar deposits include TrueUSD and Tether (USDT).
- Crypto-сollateralized stablecoins
The value of this type of stablecoin is directly related to the value of other cryptocurrencies. Since the underlying asset is also a cryptocurrency, in this case, it is usually insecure and can also be very volatile.
In this case, issuing a small number of tokens may require a relatively large number of reserve cryptocurrencies. It suggests the over-collateralization of this stablecoin type.
- Non-collateralized (algorithmic) stablecoins
Non-collateralized stablecoins are those that do not involve the use of any reserve asset. The work of the Central bank influences their stability directly.
For example, the cryptocurrency base coin uses a consensus mechanism to determine whether it should increase or decrease the supply of tokens on a need basis.
The underlying cryptocurrency coin uses a consensus mechanism to determine when to increase or decrease the number of tokens.
While it may seem obvious, stablecoins are designed to have much lower volatility than conventional cryptocurrencies such as Bitcoin (BTC) and Ethereum (ETH). This is because they are tied to the value of an underlying asset – most often the United States dollar (USD) or gold – and generally do not deviate too much from the market price of that underlying asset.
This property makes stablecoins the perfect escape from volatility for cryptocurrency traders, allowing them to exit their positions into a stable price asset as needed to lock in profits or avoid losses.
Before using stablecoins, crypto traders could exit one volatile asset by buying another that is not very volatile. This represented a sub-optimal solution at times when the vast majority of assets lost value, as traders had little or no opportunity to lock in the value of their portfolio without cashing out completely.
The popularity of the cryptocurrency industry grew among institutional investors, stablecoins represented an easy way for these major market players to maintain the value of their portfolio during a downturn and completely exit their position when necessary by exchanging their stablecoins for the underlying asset. with a stablecoin issuer.
Stablecoins Solve an Important Problem
Stable digital currencies are pegged to real assets like the US dollar or the Euro.
Risk aversion is a simple but important problem that stablecoins solve. By giving us mental stability, stablecoins not only automatically provide utility, but also become a bridge between the world of digital tokens and the world of fiat money.
Convenience Is a Key
Since stablecoins are mostly made up of code, features can be added to them to adapt to changing needs. For example, loyalty programs could be embedded in branded stablecoins, such as the upcoming Walmart stablecoin. By creating loyalty programs based on the company’s “branded” stablecoin, loyalty is directly integrated into the user experience. Users could easily check their stablecoin balances and loyalty rewards in one app, getting rid of inconvenient bonus cards. Stablecoin’s integration with loyalty programs provides an easy-to-use customer experience in a saturated loyalty market where convenience is key.
Distinctness, Safety, and Stability
When it comes to investments, stablecoins are here to help users get rid of the oppression of uncertainty.
What about safety? Stablecoins provide people with a safe and stable place to store assets. Those with stablecoins know that it is possible to convert other crypto investments to stablecoins quickly and easily if there is some uncertainty.
Stablecoins are safe and stable for storing assets. Converting crypto investments into stablecoins doesn’t take a lot of time and quite an easy process. So users can store their funds in cryptocurrency without worrying about a sharp drop in price. In this case, the problem of uncertainty is eliminated by itself.
You have familiarized yourself with some important features of stablecoins. Now you can independently analyze why they are so important for the entire market and users in general. All of the above benefits help to promote and popularize stablecoins.
At the moment we can assume, that user demand for stablecoins will grow up in the nearest future.