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Stablecoins: A Beginner's Guide

Published on
June 22, 2022
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Stablecoins: A Beginner's Guide

Stablecoins are cryptocurrency tokens with a fixed value and are not subject to volatility fluctuations. Most stablecoins are backed by reserve assets such as US dollars, gold, or other digital cryptocurrencies.

Stablecoins are decentralized digital money created using blockchain technology that underpins volatile cryptocurrencies. Stablecoins, unlike constantly fluctuating cryptocurrencies, maintain a constant value, allowing you to utilize them for digital payments with confidence.

Stablecoins are a kind of cryptocurrency that can be utilized to store value.

Stablecoins, like the dollar in your wallet or bank account, maintain a consistent value. On a forex market, look at the US dollar. Its value does fluctuate, but not enough to be noticed on a day-to-day basis.

Stability is an essential feature of helpful money. To achieve equivalent stability, cryptocurrencies must be anchored to another stable asset. Because of its prominence as the world's reserve currency, the pegged asset is almost always the US usd. Many USD stablecoins, such as USDT, USDC, and BUSD.

A few simple ways to connect stablecoins to stable assets. Backing a stablecoin 1:1 with assets in reserve is the most basic and popular technique to protect it from price fluctuations. This means having $1 in reserve for every 1 USDC produced for stablecoins like USDC.

Stablecoins, on the other hand, do not have to be pegged to dollars. You may collateralize stablecoins with a basket of assets, including cryptocurrencies, as DAI, TerraSDR, and sUSD stablecoins have shown. Some, like Meter, rely on the global electrical market for stability rather than fiat.

Some stablecoins are completely uncollateralized. Algorithmic stablecoins use elastic supplies to maintain a peg with a targeted asset by expanding and contracting token supply.

Types of stablecoins

Stablecoins now has a market capitalization of $100 billion. Many Latin Americans presently use them for trading crypto, earning interest in DeFi applications, and protecting their wealth from local currency volatility.

The types of stablecoins accessible are expanding as the demand for digital currency develops.

Stablecoins in the form of digital dollars

The most famous stable digital currencies right now are dollar-pegged stablecoins. They are digital representations of physical dollars since they have a 1:1 backing with dollars in reserve.

Tether (USDT) was the foremost digital dollar stablecoin to garner widespread adoption, and it is currently widely used on crypto exchanges. Traders can swiftly shift funds between digital wallets, keep them on hand for market buying opportunities, or cash out to USD using Tether and other popular digital currencies like USDC.

Stablecoins with crypto-collateral

Cryptocurrency adoption and usage are on the rise, implying that there are more crypto-asset holders than ever before. Because so many people are long-term investors, utilizing crypto to collateralize and issue stablecoins makes sense because it increases the liquidity of the collateral without compelling the holder to sell.

The process of collateralizing and issuing stablecoins with crypto collateral is simple. You deposit crypto in a stablecoin vault, such as Maker DAO, and then manufacture stablecoins (in Maker's case, DAI) against your collateral. DAI is taken from the supply when you repay your loan and withdraw the collateral.

Furthermore, the programmability of blockchains like Ethereum opens up a whole new world of reliable synthetic assets or assets that look like others. Consider a plastic banana, which resembles a real banana but isn't. Synthetix sUSD is an example of stablecoin synthetic assets. Synthetix issues sUSD from a vault backed by SNX tokens.

Stablecoins based on algorithms

Other assets back or over-collateralize digital dollar stablecoins and crypto-collateralized stablecoins. This protects them from price volatility and black swan events, but it comes at the expense of collateral sourcing, security, and storage.

Tether, Maker, and Synthetix are reserve bank-style stablecoins, whereas algorithmic stablecoins are not. Algorithmic stablecoin systems are active open market participants that purchase and sell their coins rather than depending on a reserve full of collateralizing assets. Their market-making efforts push the stablecoin closer or further away from the peg.

Terra's UST is an algorithmic dollar stablecoin that rewards arbitrage opportunities between UST and Terra's LUNA token. The protocol's stabilizing mechanism swaps $1 worth of LUNA for $1 value of UST when UST exceeds the $1 peg. This procedure allows you to sell each UST for more than $1 on the market, diluting the UST supply and bringing the UST back to its USD peg.

Stablecoins provide several advantages.

Even when the volatility is volatile, stablecoins stay stable. When you need to shift money around or take profits on crypto trades, their value-securing capability makes them your best buddy.

Stablecoins are, in the end, a functional digital currency in a variety of situations. Let's look at some of the cases in which they thrive.

The currency that serves as a haven

If you wanted to secure your hard-earned gains from crypto market downturns before stablecoins, you had no alternative but to sell to fiat currency.

Cashing out your crypto resulted in a taxable event and a departure from the crypto ecosystem. Before fiat to crypto onramps became as rapid and efficient as now, the latter was a significant hassle. As a result, traders were stuck when it came to limiting risk exposure.

Stablecoins provide merchants with a secure place to store their funds. Thanks to them, you can maintain all of your gains in crypto while lowering your exposure to price volatility in investments like BTC, ETH, DOGE, and LTC.

After weathering the last storm, you may quickly re-enter the market with your stablecoins using the numerous USDT, USDC, and DAI trading pairs available on Coinbase, Binance, Kraken Gemini and Huobi.

Payments with no borders

Assume you need to transfer money between Coinbase and Binance. Transferring BTC or ETH is difficult due to value fluctuations and network congestion. Rather, convert your funds to stablecoins before sending them. This way, no matter how much time passes in transportation, you'll always know how much money you're getting.

Stablecoins such as USDT can also be sent utilizing alternative blockchains such as Polygon, Tron, Avalanche, and Solana. These chains are all far faster than Ethereum and cost significantly less for each transaction.

Stablecoins can also be sent anywhere without any geographical limits, which is a compelling use case. Have you tried moving money across PayPal accounts in different countries? When it works, it's a pain and expensive, but when it doesn't, it's aggravating.

When sending stablecoins between crypto wallets, however, there are no limits. Someone in the United States can transmit stablecoins to a friend in France in minutes for very little money. The buddy in France can cash in euros at the best available exchange rate.

Buy NFTs, use DeFi, and play crypto games.

Stablecoins make cryptocurrency applications more widely adopted. For example, you can load your stablecoins into a MetaMask crypto wallet, then deposit them in high-yield crypto savings account like Compound by converting cash to stablecoins on Coinbase.

Purchasing NFTs is the same way. The days of paying for NFTs with volatile ETH tokens are long gone. You may bid on artworks and pay for NFTs with stablecoins like USDC on NFT sites like Zora. This way, you can see how much money you're spending in a dollar amount.

In-game payments require price stability as well. Gaming has evolved into a worldwide, massively multiplayer sport. Players need frictionless money that can process many payments in real-time. Blockchain gaming sites are already using the Circle's USD Coin as they bring stablecoin capabilities into the mainstream.

Stablecoins that are the best

Every day, new stablecoins appear on the crypto market. Which stablecoins are the most secure, reliable, and widely used? Here's a list of the greatest stablecoins currently available.

DAI

DAI is a decentralized stablecoin created by the Ethereum-based Maker DAO technology. It will help if you put ETH in Maker's reserve vault to mint DAI. DAI's price is linked to the US dollar.

DAI has maintained its price peg for more than six years and has developed to become one of the most liquid stablecoins in the crypto world.

USDT

Tether (USDT) has a tumultuous history in the crypto world, but that hasn't stopped it from being the most widely used stablecoin. USDT is a dominant trading pair in every market.

USDT trading volumes on some exchanges exceed those of BTC pairings, implying a loss of BTC market dominance and a possible decoupling of the market from Bitcoin.

Several audits have proved Tether is over-collateralized and secure after years of uncertainty about whether USDT stood backed 1:1 with dollars in reserve. Coinbase's recent move to officially put USDT on its exchange is perhaps the most significant indication of USDT's credibility.

USDC

USDC is a stablecoin created by Circle, a Goldman Sachs-backed payments firm. USDC is an institutional-grade digital currency with a regulated infrastructure and a 1:1 dollar reserve.

USDC has quickly gained traction due to its compliant nature and institutional backing, and it is already a widely accepted stablecoin on crypto exchanges and businesses. On the Ethereum, Algorand, and Solana blockchains, roughly $750 billion USDC has been moved so far.

BUSD

While USDC is Coinbase's unofficial stablecoin, Binance established Binance USD (BUSD), which is an official stablecoin.

Binance is the most popular crypto exchange in the world. Thus, launching BUSD was a natural step for the company. Binance teamed up with Paxos to create BUSD. They've amassed a sizable reserve of audited US dollars in FDIC-insured institutions.

Outside of Binance, BUSD isn't extremely popular, but given the size of Binance's user base, the stablecoin reaches a broad audience by default.

UST

On the Terra blockchain, UST is an algorithmic stablecoin. UST can be purchased directly on KuCoin, TerraSwap, or Mirror Protocol, or it can be created with LUNA tokens.

Outside of the Terra DeFi ecosystem, UST is difficult to come by. UST is the largest algo stablecoin by market cap due to the sheer volume of Terra apps and their popularity in South Korea.

Diem

Diem is a worldwide digital currency that Facebook is developing. It employs a blockchain-based payment system to fight with upcoming central bank digital currencies (CBDC).

While Diem is yet to be released, we can only presume that Facebook's stablecoin will quickly become one of the world's most widely used digital currencies. Why? Because Facebook has a user base of approximately three billion people.

Stablecoins have several issues.

Stablecoins are a familiar approach for those used to traditional cash to begin utilizing digital currencies. Stablecoins, on the other hand, have some drawbacks.

Centralization:

USDT and USDC are dollar-backed stablecoins managed, audited, and minted by centralized reserve bank institutions. As we saw with Tether, the entire crypto ecosystem is jeopardized if the parent company is at risk.

Unsecure:

The custodians of collateralized stablecoins are responsible for safely storing the collateral assets. As a result, the risk is centralized, giving algo stablecoins an advantage. Algo stablecoins, on the other hand, are under-collateralized, leaving them vulnerable during black swan events.

Non-transparent:

Because most stablecoins are operated by centralized companies, much of the activity surrounding them, including their backing, takes place off-chain. It might be difficult to tell whether a stablecoin is completely backed, and solutions can be challenging.

When an issue with one model arises, the cryptocurrency ethos mandates that the solution is to innovate rather than rely on established frameworks. As a result, while some of today's most popular stablecoins are centralized and well-established in the market, decentralized equivalents are swiftly gaining traction.

Stablecoins have also had to come clean to thrive due to growing regulatory scrutiny on the overall market. Tether's legal struggle with the New York Attorney General and subsequent settlement is a good illustration.

Stablecoins will become increasingly important within financial infrastructures as the landscape becomes increasingly dominated by digital currency. Regulation will follow suit. US regulators removed the way for banks to settle stablecoin payments in early 2021. While the verdict is a success for digital currency, it also implies that stablecoins, like traditional money, will be extensively regulated.