Table of Contents
- KEY TAKEAWAYS
- WHAT’S THE POINT OF STABLECOINS: HOW TO BUY STABLECOINS
- HOW TO BUY STABLECOINS
- WHAT IS A STABLECOIN?
- WHAT ARE STABLECOINS USED FOR?
- TYPES OF STABLECOINS AND HOW THEY WORK
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A stablecoin is a cryptocurrency whose value is linked to another asset, typically a currency like the U.S. dollar or the Euro. This type of crypto coin tracks the underlying asset, ensuring that its value remains steady over time, at least relative to the currency to which it is linked.
KEY TAKEAWAYS
- Stablecoins are built to maintain a stable price, ideally a 1:1 ratio with the U.S. dollar.
- Stablecoins, except algorithmic stablecoins, are backed by collaterals which may be fiat currency, cryptocurrency, or a physical commodity.
- Stablecoins offer a variety of utilities such as trading, easy purchasing, cross-border payments and usage in DeFi applications.
WHAT’S THE POINT OF STABLECOINS: HOW TO BUY STABLECOINS
Blockchain and, indeed, cryptocurrency has become a household name in the financial world of the 21st century. Cryptocurrencies' popularity is growing daily among active participants, enthusiasts, and sceptics. Cryptocurrencies are here to stay. The cryptocurrency market has evolved rapidly since the debut crypto, Bitcoin, launched in 2008.
Cryptocurrencies have different use cases; one such use is a store of value. However, the volatility of the crypto market may limit many users, with many would-be users being repulsed by the volatility. Thus, stablecoins came into the scene as a soothing balm to mitigate price volatility.
Even though cryptocurrency was built to offer cross-border and decentralised solutions to the shortcomings of the traditional banking system, volatility remains a double-edged sword users must deal with. Volatility is the ease with which the price of an asset changes over time. For crypto traders, volatility is a great tool to make money in the market if they make the correct price speculation. However, volatility makes routine transactions such as purchases unprofitable for buyers and sellers. Rapid price changes can alter the value of payments in the twinkling of an eye.
For cryptocurrencies to serve as an effective medium of exchange, volatility must be zero or nearly so for prices to remain stable over time—this is where stablecoins come in as a solution. Stablecoins maintain a constant value over time, unlike most other cryptocurrencies that are dynamic in price movement.
HOW TO BUY STABLECOINS
Stablecoins are easily accessible and extremely liquid; thus, they can be bought and sold without hassle. Stablecoins are available on peer-to-peer platforms, centralised and decentralised exchanges.
Step 1: Deposit local fiat currency via direct deposit,card or e-wallet payment.
Step 2: Purchase stablecoins of your choice.
Step 3: Transfer to your personal wallet, staking pool to earn rewards or keep your stablecoins on the exchange wallet.
Some of the most popular exchanges for purchasing stablecoins are Binance, Coinbase and Kraken.
WHAT IS A STABLECOIN?
A Stablecoin is a cryptocurrency that maintains a stable value by backing its value to the value of another asset, such as another cryptocurrency, fiat currency or commodity. The fiat currencies are real-world currencies like U.S. Dollar and Euro issued by the government.
In traditional banking, the government and the banking system determine the intrinsic value of fiat currencies through effective policymaking. The stablecoin, on the other hand, works on a different mechanism that is just as effective, if not more so.
Stablecoins were first issued in 2014 on the BitShares Blockchain and have grown steadily to become a top choice for a variety of utilities. According to coingecko, as of Jun 11, 2023, stablecoin’s market capitalisation is valued at
$129 Billion, representing 11.29% of the total crypto market cap. The stablecoin market will likely continue to grow as more users resort to cryptocurrency for cross-border financial solutions.
WHAT ARE STABLECOINS USED FOR?
Stablecoins have myriads of use cases; some of these include:
- Trading and Exchanges
- Remittances and cross-border payments
- Stablecoin-backed loans and financial services
- Instruments in Decentralised finance (DeFI) applications
- Staking assets for passive income
Read more: What’s staking in crypto?
TYPES OF STABLECOINS AND HOW THEY WORK
Fiat-collateralised stablecoins
Fiat-collateralised stablecoins harness a fiat currency (or currencies) such as the U.S. Dollar as collateral to maintain its value. Tether USD(USDT) is by far the most popular stablecoin that is pegged to fiat USD. The Tether USD: fiat USD ratio is ideally maintained at 1:1. This ratio is sustained by issuing an equivalent quantity of USD for every USDT to peg the price of USDT at $1.000 nearly always. This means that 1 USDT can be traded for 1 U.S. dollar.
If a user intends to get 100 USDT, he needs to deposit $100 into the Tether reserve to maintain the 1:1 parity. New Tether tokens are allocated to the user while the $100 is stored as a reserve in audited bank accounts. When a user wishes to convert their USDT to USD, the corresponding amount of USD is retrieved from the reserve.
More examples of fiat-collateralised stablecoins include:
- USD coin (USDC)
- Binance USD (BUSD)
- True USD (TUSD)
- Paxos Standard (PAX).
Commodity-backed stablecoins
Commodity-backed stablecoins are stablecoins that are pegged to the price of real-world physical commodities such as gold and silver. Like fiat-collateralised stablecoins, commodity-backed stablecoins are maintained at a ratio of 1:1 with the underlying commodity to maintain price stability. They allow users to leverage the advantages of both cryptocurrencies and precious metals, diversify their portfolios, and protect themselves from market volatility.
A good example is the Pax Gold (PAXG) token, backed by an ounce of physical Gold. PAXG tokens are created and destroyed by Paxos as needed. In essence, the price of PAXG is the same as that of an ounce of Gold.
To ensure the system's transparency, independent auditing systems ensure the issuers of commodity-backed stablecoins don't tamper with the underlying physical commodity in reserve.
Other examples of commodity-backed stablecoins include:
- Tether Gold (XAUT)
- Digix Gold (DGX)
- Gold coin (GLC).
Crypto-collateralised stablecoins
Crypto-collateralised stablecoins are stablecoins backed by another cryptocurrency. The underlying cryptocurrency itself is usually volatile; hence, a safety measure is needed to protect the stablecoin against market volatility. A strategy known as over-collateralisation is employed. This means that the value of the reserve cryptocurrency issued exceeds that of the stablecoins issued.
A cryptocurrency worth $100 million might be held in reserve to issue $25 million of a crypto-backed stablecoin. This will insure against a 75% price drop of the reserve cryptocurrency. For instance, MakerDAO's Dai (DAI) stablecoin is backed by Ethereum (ETH) and other cryptocurrencies worth 150% of the DAI stablecoin in circulation while still being pegged to the U.S. Dollar.
The downside of this mechanism is that in a strong bear market, crypto-collateralised stablecoins can depend, causing losses for investors.
More like this: How to maximise yields on crypto
Other examples of crypto-collateralised stablecoins include:
- Synthetix USD (sUSD)
- Synthetix EUR (sEUR)
- BitUSD (BITUSD)
Algorithmic stablecoins
Algorithmic stablecoins are stablecoins that are uncollateralised, meaning there are no underlying collateral assets like most other stablecoins. Instead, algorithms are employed to control the supply of stablecoins using protocols built into smart contracts. This mechanism is a novel one which unfortunately failed in the case of Terra USD causing a loss of 80% of its value overnight on May 11, 2022, leading to an 80% fall in the price of the Terra Luna’s native token.
Other examples of Algorithmic stablecoins include:
- Ampleforth (AMPL)
- Frax (FRAX)
- Empty set Dollar (ESD)
Hybrid stablecoins
Hybrid stablecoins are stablecoins that use a combination of collateral types. Hybrid stablecoins use a combination of fiat, commodity, or crypto-collateralised mechanism to maintain their peg against the U.S. Dollar.
Popular examples of hybrid stablecoins include:
- Reserve Rights (RSR)
- Venus BUSD (VBUSD)
- Venus (XVS)
- Liquidity (LQTY)
FINAL THOUGHTS
Stablecoinsoffer a square peg in square holes solution to the downsides of volatility in crypto with ever-evolving utilities across many blockchain domains, attracting more users to embrace the use of cryptocurrencies utilities over time.
About the author
Adebajo Glory is a certified professional blockchain freelance writer with several published blockchain architecture and managementarticles.
REFERENCES
https://originstamp.com/blog/the-history-of-stablecoins-reasons-they-were-created/
