What Is a Stablecoin?

A lot of blockchain investors are getting nervous about stuffing their crypto wallets with bitcoin. After all, there’s been volatility to the tune of billions of dollars πŸ’°! But did you know that stablecoins are here to manage that volatility πŸ’ͺ? What is a stablecoin, exactly, and how can it help? 

As their name suggests, stablecoins are a more stable asset you can invest in. You can invest in them without worrying about the normal volatility in the cryptocurrency market 😎. Keep reading to learn more!

What Is a Stablecoin?

A stablecoin is a digital asset πŸ‘©β€πŸ’» with a value pegged to a real-world asset. This can be any number of sovereign currencies, such as the US dollar reserve currency, Canadian dollars, or other foreign currencies. Such currencies are normally pegged to a stable reserve asset such as gold ⚱️.

The idea behind a stablecoin (also algorithmic stablecoins) is to give you a less volatile coin than other crypto assets for stable and reliable investments πŸ™Œ. This real-world connection makes stablecoin safer than other cryptocurrencies/types of assets on the blockchain network.

You can purchase stablecoins on cryptocurrency exchanges or through peer-to-peer platforms.  Once you have some stablecoins in your digital wallet, you can use them to avoid trading fees when making purchases or payments πŸ’΅ (including cross-border payments and international payments).

How Does a Stablecoin Differ From Regular Cryptocurrencies?

Both stablecoins and other cryptocurrencies are digital cash πŸ“² than can be used as a form of payment. Here are the principal differences: 

  • A cryptocurrency is not pegged to any other asset, making its price vulnerable to crypto volatility.
  • A stablecoin is pegged to another asset like the U.S dollar rather than being standalone digital money. Hence, its price is much less volatile than that of cryptocurrency.

Risks Associated with Stablecoin

Like any other digital currency, stablecoins have risks ⚠️. Here are a few you should be aware of. 

Counterparty Risk

The value of a stablecoin is only as good as the digital cash it is pegged to. Even fiat-backed stablecoins will lose value if the digital cash loses value πŸ“‰.

Risks Due to Regulatory Actions

Currently, stablecoins are not subject to many regulations. However, this situation could change in the future. Some government officials are nervous 😰 and fear the potential that stablecoins pose a serious risk to financial systems and could replace commercial paper currency.

After regular audits of stablecoin issuers, such governments could introduce a tighter regulation 🦾 of stablecoins that negatively impact their value. That could have a significant impact on the circulation of stablecoins. However, that’s really all speculation for the time being. 

Types of Stablecoins

You can identify a type of stablecoin based on what they are backed by. Here we have four types you should be aware of 🦾. 

Fiat-Collateralized Stablecoins (Traditional Asset-Backed Stablecoins)

Fiat-backed stablecoins are the most common type. They’re backed by a reserve of fiat (government-backed) currency such as the actual dollars πŸ’°.

Because they’re backed by a real asset/central bank digital currency, there’s normally a lot of price stability to fiat currency. However, it is subject to the same volatility as the fiat national currency or cash equivalents πŸ’΅. For example, if a country has an unstable government and its legal tender fluctuates, a fiat currency tied to it will also dip. 

Cryptocurrency Asset-Backed Stablecoin

A crypto-backed stablecoin is backed by a reserve of cryptocurrencies such as Bitcoin or Ethereum. It’s not subject to the extreme price volatility of fiat currencies or cryptocurrency spot prices. Instead, a crypto-backed stablecoin is subject to the volatility of the type of cryptocurrency assets.

Commodity-Collateralized Stablecoin

Commodity-backed stablecoins are backed by a reserve of commodities such as gold or silver. They aren’t connected to a real currency like the American dollar πŸ’΅, which is subject to regulatory bodies. That makes them subject to the volatility of these commodities, but they’re not subject to the volatility of fiat currencies and cryptocurrency spot prices.

Non-Collateralized Stablecoins

Non-collateralized stablecoins aren’t backed by any asset, meaning you don’t have to worry about them being subject to the volatility of other financial systems. However, since non-collateralized stablecoins are backed by nothing, they are more prone to price manipulation 🧐.

Examples of Prominent Stablecoins

Ready to do some buying? Tether (USDT) is the most popular stablecoin pegged to the USD coin. It’s also the third-largest cryptocurrency out there. The USDT token is issued by the company Tether, a creator of the popular cryptocurrency exchange Bitfinex. Within the circulation of stablecoins, every USDT token is backed by one U.S dollar πŸ’°.

Other examples of stablecoins include TrueUSD (TUSD), Standard (PAX), and the EURS.

Algorithmic stablecoin TerraUSD uses algorithms to keep its price stable.

You can use the USDT token or other private stablecoins to:

  • Help stabilize the price of other cryptocurrencies. For example, if the price of Bitcoin falls πŸ“‰, you can invest money with stablecoins to get your money out of Bitcoin. The demand for USDT draws Americans’ attention to stablecoins, which can help stabilize the price of Bitcoin.
  • Avoid fees. Most crypto exchanges don’t charge fees when swapping US dollars for private stablecoins. 
  • Trade other cryptocurrencies. For example, you can purchase Bitcoin and other cryptos with USDT on an exchange like Binance. 

Stablecoins in the Metaverse

If you’re looking for a stable currency alternative to other cryptocurrencies and traditional currencies, stablecoins are a good choice. They’re an excellent way of trading in the metaverse without worrying about the volatility of the crypto market and price fluctuations.

Some experts and algorithmic stablecoin issuers believe that stablecoins will become a popular way to store actual cash reserves and exchange currency in the near future πŸ€‘. Others believe that the adoption of stablecoins is primarily for speculative purposes. However, because they are more stable, stablecoins are as likely to stick around as any other crypto coin (perhaps more).

Worried about the latest news on stablecoins and another blockchain tech? Stay on top of those and other Web3 news with the Ian Corzine newsletter! We’ll keep you appraised πŸ€— on blockchain technology, the stablecoin market, smart contracts, and much more.