What are Stablecoins and Why They are Important?
After Bitcoin, a plethora of altcoins started entering the market, some decentralized, some were not. But one thing that stayed stable is the instability of cryptocurrency’s market price, especially the leading currency in the crypto market, Bitcoin. Tackling the problem of constant fluctuations, came stablecoins.
What are Stablecoins?
Stablecoins are the revolutionary category of cryptocurrencies that came with the promise of offering the best of both in the crypto world. The concept is based on facilitating cryptocurrency that is backed up by central monetary authorities. This digital asset is meant to preserve the quick processing and security component delivered through cryptocurrency while maintaining stability in the monetary valuations of fiat currencies.
Types of Stablecoins
In terms of being pegged to fiat currency or any other monetary asset in order to solve the volatility factor that comes with cryptocurrency, there are several types of stablecoins-
Fiat-Backed
As the name suggests, fiat backed stablecoins are collateralized by traditional currency like the US dollar, Nigerian Naira and the British Pound. Fiat-backed stablecoins are deemed more suitable for regular use on exchange platforms. True USD, Tether USD, Pexos Standard Token and USD Coin are all great examples of Fiat-Backed stablecoins.
Crypto-Collateralised Stablecoins
These stablecoins run on the same concept as fiat. But instead of fiat currency, they are backed by cryptocurrencies. Using cryptocurrencies as an alternative to fiat in terms of back up, preserves the decentralized nature of the network as every transaction stays contained and untouched on the blockchain.
The only complication that comes with crypto-collateralised stablecoins is the matter of maintaining stability right in the middle of the fluctuating crypto market. Maker DAO is a great example of a stablecoin that tackles this problem with over collateralising every coin instead of maintaining 1:1 ratio as Fait-backed stablecoins does. Synthetic is another example of crypto-collateralised stablecoin.
Algorithmically Stabilized Stablecoins
These kinds of stablecoins are based on the algorithm that works on balancing the supply of the coins in terms with the market price. For instance, if the market price of this stablecoin rises, more coins will be issued and similarly the quantity of the issued token will be reduced if the price of the asset falls.
Why are Stablecoins Important?
It is not a surprise that it’s basically impossible to have any price prediction of bitcoin. The currency has become an entity representing uncertainty itself. This kind of nature attached to a monetary asset makes it unattractive for daily use. The massive surge and meteoric falls in bitcoins have left analysts and crypto experts helpless in observing a pattern that may explain the fluctuations in the market. It was barely three years ago in 2017 when bitcoin saw its unprecedented high and followed by a meteoric fall in less than a year. As recently as this year, 2020 witnessed the inevitable bitcoin halving and left the BTC reward at 6.25. The market value of bitcoin rose, going over $9000 USD during the time of halving ie. May 2020.
Avoiding instability is the biggest selling point of stablecoins facilitating surety and security to the currency owners. A currency is meant to act as a medium for practicing monetary exchange and that requires stability relative to the long term use of the currency. With the component of potential investment, currency should encourage expenditure. These are exactly the factors that stablecoins aim to target.
Use of Stablecoins
With the variety in the types of stablecoins, their usage has exponentially increased over the years in trading, payments and methods of earning.
Trading
The ability of stablecoins to create a barrier against volatility has made it extremely useful for cryptocurrency users to treat it as a base asset while trading. Such assurity allows crypto traders to exchange funds more often and at a low price. With fiat-backed stablecoins, traders can flawlessly move funds in their banks.
Digital Payments
The volatility with cryptocurrency cannot be handled with everyone and hence payment systems through crypto assets are dropped quite quickly. In instances where an invoice worth $100 is paid in terms of bitcoins, it can lose its value to far less in just a couple of hours given the unpredictable fluctuations in the market, where the company facilitating cryptocurrency payment can end up losing quite a sum of money. To avoid such instances, using stablecoins or accepting other currencies to turn them into stablecoins can ensure financial stability.
Earn from Stablecoins
Like bitcoin has the option of mining and earning BTC directly through it, stablecoin allows income through stabilization or its creation. For example, by holding Maker DAO’s DAI token, you can earn some passive income.