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June Katz 23 Aug 2023 ◦ 4 min read

Stablecoins Made Simple: What You Need to Know

Stablecoins Made Simple: What You Need to Know

In the financial area, disputes over the cryptocurrency value still do not subside. The opponents of crypto consider digital assets as just a cryptographic code that is not backed up by anything tangible and has no real value. According to them, it leads to constant price changes. Given the high volatility conditions and no guarantee of growth, it becomes quite risky to invest in cryptocurrencies. Cryptocurrencies called stablecoins were designed to solve the problem of volatility. 

What is a stablecoin?

Stableсoin is a cryptocurrency pegged to the value of traditional financial assets like fiat money, oil, precious metals, etc. Backing the cryptocurrency rate up to the prices of such assets is an attempt to adapt digital technology to real life. Such a way makes it possible to use stableсoins as a regular means of payment. 

Types of stablecoins

Stablecoins can be distinguished into three types:

  • Commodity-backed (pegged to traditional assets like gold, oil, etc.);
  • Fiat-backed (pegged to fiat money like dollar, euro, yen, or other currency);
  • Crypto-backed (pegged to the top cryptocurrencies like Bitcoin or Ethereum);
  • Seigniorage-style (not backed). Seigniorage-style tokens can have any price because it is not attached to something tangible. Such coins differ from ordinary cryptocurrencies in the functions of smart contracts using algorithms that let increase or decrease the volume of offers automatically to stabilize the price.

Advantages of stablecoins

  • Low level of volatility, cause the price directly depends on the real asset rate.
  • Low level of inflation, which is an additional incentive to spend them, and not to hold.
  • New opportunities in the development of the cryptocurrency industry and digital assets. For example, stablecoins make it possible for credit and insurance services to be designed on the blockchain, avoiding the risk of sharp jumps in the rate like ordinary cryptocurrencies.

Disadvantages of stablecoins

  • Pegging to fiat currencies. For example, if the price of a token is baсked up by the dollar, then such tokens become derivative and depend on the financial law.
  • Pegging to cryptocurrencies. The sharp collapse of the cryptocurrency exchange rate, which is provided by stablecoin, can almost completely depreciate it. 
  • The need for intermediaries, which increases the risks of uncontrolled emissions, and decentralization is not even discussed.

History

The first mention of stablecoins and its definition as a special type of cryptocurrency arose in 2012 with the advent of the Mastercoin project, which was due to Bitcoin. However, the developers did not finish the project, so Mastercoin soon became forgotten. The first stable token was issued in 2015 by Tether Limited company – Tether (USDT). Initially, USDT was pegged to the US dollar at a 1:1 rate. The next stage was the creation of stablecoin pegged to gold. In 2016, the DigixDao project arose based on the Ethereum blockchain. The cryptocurrency rate was tied to gold in the rate of 1 coin to 1 gram of 999.9 gold. Later the new crypto projects began to represent coins provided with oil and valuable minerals (lithium, zirconium, etc.). A large number of different technical approaches to the design of stablecoins were developed and implemented, but generally, they are backed up either by assets or algorithmically. Maker's Dai stablecoin is the largest stablecoin supported by crypto assets. Thus, stablecoin can be provided with fiat currencies (one or more), physical assets (gold), or one or more cryptocurrencies. El Petro is the national cryptocurrency of Venezuela released on the NEM blockchain. Its price is pegged to oil. The development and introduction of this cryptocurrency was a necessary step for Venezuela which has unsuccessfully been fighting against hyperinflation. At the state level, all large oil companies are required to carry out at least part of the calculations in El Petro. Venezuelan citizens can use the coin for settlements with government organizations. Today, the most hyped projects with stablecoins are Facebook IT Corporation with its cryptocurrency Libra and JPMorgan banking conglomerate with JPM Coin stablecoin. They are the closest to the goal to become the most realistic and promising solutions for designing a new type of payment and transfer system. In fact, stablecoin is a kind of compromise between traditional and digital assets. It loses some of the signs of a regular cryptocurrency but receives the characteristics of a real means of payment.

What are stablecoins needed for?

Stablecoins can be used in most cases as other cryptocurrencies, with the added advantage of price stability. In certain conditions and for a number of products and services cryptocurrency with high volatility, such as bitcoin, may be inappropriate or even unsuitable. For example, if you regularly make payments for rental housing, then it is not recommended to store the funds for these payments in such a volatile currency as Bitcoin. However, BTC is more suitable for investment. Stablecoins can be used for money transfer, derivatives/lending, dApps (decentralized applications), as a means of savings, means of exchange, a measure of value, etc. Stablecoins can solve the problem of volatility in the cryptocurrency market, which hinders the development of the entire industry. And since stablecoins themselves are designed on the infrastructure created by Bitcoin and Ethereum, they should not be considered as competitors to classic currencies, cause it can bring great benefits to the entire ecosystem of digital assets.

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