Have you ever heard of stablecoins? With the development of the cryptocurrency market, stablecoins were created to provide more stability and facilitate transactions as they are less volatile than other cryptocurrencies. In this article, you will learn more about them and how they differ from other cryptocurrencies, such as Bitcoin.
What Are Stablecoins?
Stablecoins are cryptocurrencies whose value is tied to a real-world asset such as the US dollar. Therefore, their price is steadier and fluctuates less than that of other cryptocurrencies. For example, Bitcoin's price went from less than $5,000 in March 2020 to more than $63,000 in April 2021, then dropped almost 50% in the following two months.
The purpose of a stablecoin is to provide an alternative that makes everyday transactions easier. It's more difficult to use more volatile cryptocurrencies, for example, to make payments, as their values can change rapidly.
They put together the blockchain technology, which enables every cryptocurrency, with financial stability to make their use more viable as a medium of exchange. This way, they can be adopted by more people and in more transactions, not only in trading and speculation.
How Stablecoins Work?
Stablecoins pin their value to fiat currencies, commodities, and other financial instruments. Their price is supposed to be 1:1, which means if the stablecoin to pegged to the US dollar, it is worth 1US dollar.
Redemption and arbitrary create the price floor, ensuring you can always exchange the stablecoin for its corresponding fiat currency. 1 token of Fiat-backed stablecoins lUSDC or USDT, tied to the US dollar, can be exchanged for $1,00.
If the price drops, you may buy them for a lower price, then redeem them with the issuer for the fixed value. On the other hand, if the price increases, the buyer can create and sell new tokens into the market. This way, the supply is reduced when the price drops, and increased when the price is high. Auditors are used in this system to verify the reserves.
Types of Stablecoins
Fiat-Pegged Stablecoins
Fiat-pegged stablecoins are the most popular type of stablecoin. They are tied 1:1 to traditional currencies, commonly with the US dollar (USD) and the euro (EUR), such as the USD-pegged Tether (USDT) and USD Coin (USDC), and EUR-pegged Stasis Euro (EURS).
Commodity-Pegged Stablecoins
Commodity-pegged stablecoins are tied to the value of physical assets like gold and silver. For instance, each token of PAX Gold (PAXG) is worth one troy ounce of gold, backed by a gold reserve stored in a vault.
Crypto-Backed Stablecoins
Crypto-backed stablecoins are backed by reserves of a different type of cryptocurrency, as the name suggests. For example, Dai (DAI) is tied to a reserve of cryptocurrencies like Ethereum (ETH).
Algorithmic Stablecoins
Algorithmic stablecoins use programmed mechanisms and dynamic supply to maintain their prices. If the price drops, the system takes tokens out of circulation to regulate the value, and mints more if the price goes up. Ampleforth (AMPL) and Frax (FRAX) are examples of algorithmic stablecoins.
Stablecoin Use Cases
Cross-Border Transactions
Stablecoins are used for remittances as an alternative to paying migrant workers, and they avoid high fees and slow processing times. They are also used as a solution for people who don't have access to traditional financial institutions. It's possible to use a digital wallet to receive, store, and spend stablecoins.
Payments and Peer-to-Peer (P2P) Transactions
Stablecoins can also be used to make everyday payments, as there are establishments that already accept them. It's a faster and cheaper option, mainly in underbanked regions or in places where the foreign exchange fees are too high. There are stablecoin-based credit cards that allow the customer to spend using stablecoins while the business receives a fiat equivalent payout.
Foreign Exchange and Trade Finance
Importers and exporters use stablecoins as a medium for international trade, mainly in areas with difficult access to foreign currency.
Store of Value
Companies and individuals who live in areas with high inflation and unstable economies are using stablecoins to preserve their purchasing power and protect their assets from the volatility of the local currencies.
Stablecoin Pros and Cons
Pros
- Price stability: the fact that stablecoins are developed to maintain a steady price facilitates their use in daily transactions.
- Faster and cheaper transactions: stablecoins are a way to make cross-border payments quicker and cheaper because you can make them outside of traditional banking system hours and avoid paying high fees.
- Global accessibility: they are an alternative to pay and receive payments from people and businesses from different countries than yours.
Cons
- Reserve risk: Many stablecoins are backed by a reserve; you need to trust that the issuer has the means to honor redemptions.
- Depegging risk: stablecoins may not be able to maintain the peg to their underlying asset, which is their main purpose. For example, the TerraUSD algorithmic stablecoin collapsed in May 2022.
- Regulatory uncertainty: regulationsregarding stablecoins are still being developed, and they differ from country to country.
Discover Wirex
If you want to start using stablecoins and other types of cryptocurrencies, you are going to need a digital wallet to keep and manage them. Wirex is a software that allows you to buy, exchange, and store your cryptocurrency in a single app. It includes a reward program that offers cryptoback on all purchases made with your Wirex card. You can enjoy it to make trades with multiple cryptocurrencies, including Bitcoin, Litecoin, Ethereum, Ripple, Cardano, and Dogecoin.
