What is a Stablecoin?
Stablecoins have been enjoying a lot of popularity recently. Their basic feature or function is protection against the high volatility of cryptocurrencies. They also reduce the time traders need to execute individual trades. From mid-February 2020 to August 2022, their volume rose from USD 5.7 billion to USD 119 billion.
More about stablecoins
As we have already mentioned, stablecoins were originally created as a protection against the high volatility of cryptocurrencies. When trading, they are used to lock or stabilize the current value, so you don’t have to convert funds to FIAT money.
They play a very important role in decentralized exchanges that do not offer the possibility of conversion to FIAT money.
Value of stablecoins
In essence, stablecoins have 3 basic properties that determine their value on the market:
What the value is tied to:
A stablecoin can track the value of any asset. Among the most popular are coins linked to the value of FIAT currencies, most often to the USD. However, it is also possible to link them to the value of other assets, such as gold.
The value is secured by so-called collateral:
This means locking the assets and securing the desired value. Collateral options are FIAT currencies, commodities, cryptocurrencies, or a combination thereof. There is also a difference between on-chain and off-chain collateral.
Amount of collateral:
This can be complete, which means that the stablecoin issuer holds reserves at least equal to the market cap of the given coin. In the case of partial collateral, the issuer does not fully cover the entire volume of the market cap. If all holders wanted to exchange their stablecoins for the asset they are tied to, this would not be possible. This system is similar to how banks work and negatively affects the stablecoin’s stability.
In this group we can find almost all the largest stablecoins such as USDT, USDC and BUSD. These stablecoins are the blockchain equivalent of existing currencies.
In practice, it is very simple. The client transfers their funds to the company behind the stablecoin, and the company creates the same number of tokenized units to transfer to the client. They are then used in the blockchain, like any other cryptocurrency.
This type of stablecoin is backed by a collateral that can fluctuate over time. Off-chain collateralized stablecoins are very similar to tokenized assets. The process of issuing or burning them is also performed. With on-chain collateralized stablecoins, cryptocurrencies are sent to a smart contract, which then acts as collateral.
The user can issue stablecoins against this collateral and further use these at his or her discretion.
The last type of stablecoins is algorithmic stablecoins. For these tokens, there is no collateralization to secure their value and their price is maintained by another stabilization system (an algorithm). It’s arguably not the best approach, and some tokens have had problems maintaining their value.
Most used stablecoins
Let’s look at the most often used stablecoins:
Tether – USDT:
- The oldest and largest.
- Its market cap is larger than all other stablecoins combined.
- Its value is tied to the US dollar price.
- Supported by almost all cryptocurrency exchanges as well as most DeFi protocols and blockchains.
- The biggest concern regarding USDT is speculation about whether it holds sufficient reserves to cover its market cap.
BinanceUSD – BUSD:
- This is a white-label of the Paxos Trust Company, with its own stablecoin Pax Dollar (USDP).
- BUSD is a stablecoin that the company prepared precisely for the BINANCE exchange.
- BUSD is fully backed by cash and other cash equivalents.
- The downside is the almost zero use of DeFi.
USDcoins – USDC:
- Introduced by Circle.
- Functionally, it is the same token as USDT.
- USDC is a more regulated alternative to USDT and more trustworthy for users.
- USDC is supported by almost all cryptocurrency exchanges.
- VISA support.