Stablecoin fills in the gap between fiat and cryptocurrency.
Last November of 2019, the leading cryptocurrency Bitcoin’s valuation took off from more or less $5,950 to above $19,700 the following month, then wildly plunged to a $6,900 come February 2020, declining to a massive two-thirds in just a short period. These short wild swings in either direction tend to render bitcoin and other cryptocurrencies unfavourable to traders from storing it and retailers from using it for their daily financial transactions due to its high volatility and unpredictable purchasing power. It is essential for bitcoin and other cryptocurrencies if they are to act as a medium of monetary exchange and mode of storage of monetary value, to hold its value in relative stability across time.
What about Stablecoins?
With the issue of the inherent volatility in cryptocurrency prices, Stablecoins were developed to tackle this problem by stabilizing conversion rates, thereby gaining user trust and confidence for buying and selling goods and services. Stablecoins has most of the benefits being offered by other cryptocurrencies aside from being true to its name, that is, being stable, and is also digital, programmable, and blockchain-based (Ethereum). Its internet transactions are fast, direct, and immutable as it goes beyond borders without interference from governments, banks, or mediating agencies, incurring low fees in the process. Stablecoin transactions are initiated on the blockchain that makes it possible for users to monitor their transactions in all transparency, without fear of being blocked or censored. As it has practically eliminated volatility, it becomes more attractive to those seeking the alternate refuge of their assets without cashing into fiat when the crypto market fluctuates violently.
3 Types of Stable Coins to Choose From;
Stablecoins are categorized into three identifiable types, as follows:
Centralized Stablecoins Collateralized by Fiat Currencies.
The first type of Stablecoin has a collateral of 1:1 by fiat, which means, a single stable coin has a value equivalent to $1 and is backed by dollar deposits maintained by centralized independent custodians such as a bank, a company, or a government. It is regularly audited to adhere to required compliance. Such other collaterals used for crypto are precious metals like gold or silver, or commodities such as oil and gas. But most collateralized Stablecoins make use of dollar reserves. Theoretically, there should be a seamless exchange between the two without much expense. Examples are Ether (USDT), USD Coin (USDC), Gemini Dollar (GUSD).
Decentralized Stablecoins Collateralized by Crypto
The second type of Stablecoin is backed by other cryptocurrencies but without any central operator. It is governed by a consensus of providers who make part of the network. The high volatility of crypto reserves is kept in check by over-collateralization, where a $1-valued Stablecoin is worth $2 of crypto deposited to a custodian. This is to allow up to 50% of fluctuations in the reserve currency while frequent audits and monitoring are pluses to keep prices stable, thus, preserving its decentralized status. Example: Dai (DAI).
Decentralized Algorithmic Stablecoins (Seigniorage Supply)
This type of Stablecoin does away with any system of collaterals and instead makes use of algorithmic mechanisms to retain price stability. It closely monitors the movement of supply and demand, and if need be, buying coins in circulation when prices are dropping and would issue new coins when prices are rising. This consensus-based stable coin acts similarly like a central bank wherein banknotes are printed and issued whenever necessary to maintain the value of the fiat currency. In order to accomplish the goal of close valuation to a pegged asset such as the US dollar, smart contracts are utilized on a decentralized platform that can run independently.
Quo Vadis, Stablecoins?
Stablecoins are relatively new and still being developed. Although decentralized on its own, it is still being controlled and managed by a central organization for minting supply and issuing. But some have already taken decentralized paths, and Stablecoins could become a critical component in DeFi, or decentralized finance, an alternative banking mechanism based on blockchains. Though promising as it is, stablecoins are pegged on the dollar, euro, or commodities, meaning, it is heavily reliant on the traditional financial markets and, therefore, also subject to inflation. What more, it could suspect to having ties to the banking system, which is counter-indicative of Nakamoto’s vision. But with different stablecoin launchings happening each time, its trading volumes continue to rise and, over time, a regulatory compliant network resistant to censorship will emerge, thereby creating an influential crypto space which reluctant crypto doubters will find hard to resist.
To date, there are over 200 stablecoins trying to make a name for themselves, and it would be a challenge to choose which is which. Keep yourselves posted.