What is a StableCoin? A Complete Guide for Innovators
Volatility in prices of cryptocurrencies has resulted in the ability to use them as a seamless medium of exchange. A key hurdle for adoption of cryptocurrencies has come up with a solution called StableCoin, which is designed to achieve price stability while retaining the main components of cryptocurrencies.
This article is intended to understanding what is Stable Coin, why do we need it and what are its real-world applications.
We shall discuss the following topics in the article:
Stable coins aim to bridge the gap between cryptocurrencies’ benefits and the stable nature offered by fiat currencies. It is a crypto token with a value pegged to the price of a national currency to combat its volatility.
Now, the question is, why do we need a stable coin.
Though cryptocurrencies are global currencies, coins like Bitcoin and Ether are volatile. The price of Bitcoin raised from $1000 to $20000 during 2017. Since it is not sustainable, users and investors require more stability in the market.
Imagine that you pay $30 for dinner today and the same amount would be worth $40 tomorrow because the value of that crypto token went up. Small investors cannot handle that kind of volatility. Therefore, stable coins emerged as a new technique to drive the new way of adoption to cryptocurrencies.
You might think why do we need to create fiat-backed crypto tokens instead of just using fiat currency. Decentralized currencies do not require any centralized authority to bring trust in the system, thereby reducing additional costs involved.
Also, cross border payments can be made quickly with cryptocurrencies. Backing crypto tokens with stable fiat currency or assets can add more value and build more trust among investors and users.
Stable Coins are of four types:
- Fiat-backed Stable Coins
- Non-collateralized Stable Coins
- Cryptocurrency-backed Stable Coins
- Commodity-collateralized Stable Coins
Fiat backed stablecoins are crypto tokens associated with the value of a specific fiat currency. These tokens hold their value fixed at 1:1 ratio.
For example, Tether is a stable coin, which is pegged 1:1 to the US dollar. Fiat currency is deposited as collateral to ensure the existence of a fiat-backed stablecoin. As a result, it requires financial custodian and regular auditing to determine that the token always remains collateralized.
Non-collateralized stablecoins are based on the concept of a Seigniorage Shares system. Seigniorage is the difference between the value of money and its printing cost.
These coins depend on the algorithm, which changes the supply volume to control their price. Using smart contracts, these stable coins are sold if the price falls below the pegged currency and more tokens are supplied to the market if its value rises above the pegged currency.
Cryptocurrency-backed stable coins work similarly to that of a fiat-backed stablecoin. However, it locks up cryptocurrency as collateral instead of using fiat currency. For example, Ethereum can be kept as collateral to create a cryptocurrency-backed stablecoin.
These tokens use a security pledge to compensate for the volatility of cryptocurrency to be used as collateral. It states that the stablecoin will not be based on 1:1 ration for the crypto collateral.
For instance, if a cryptocurrency-backed stablecoin is pegged to the US dollar, it can be something around $2 peg for each $1 coin issued.
Commodity-backed stable coins hold a tangible asset with some real value. These commodities can appreciate value over time, which offers an increased incentive to people to use and keep these coins.
Using commodity-collateralized stable coins, anyone can invest in real estate properties or precious metals across the world. Generally, the investment in such assets is only reserved for the wealthy class of investors. However, stablecoins open up investment opportunities for average individuals globally.
A stablecoin is a cryptocurrency that offers low volatility against the world’s major national currencies, unlocking the benefits for decentralized technology. In a nutshell, stablecoins can be defined as a cryptocurrency with a fixed price.
A reliable stablecoin offers a number of use cases than that of the blockchain. People no more need to worry about the fluctuations in prices of the cryptocurrency daily while buying them. Stability in cryptocurrencies allows people to transact quickly and it also enables other crucial financial functions, including credit and loans.
Moreover, a stable decentralized currency could become a global currency by allowing trustless and cross-border transactions. It will especially benefit people residing in countries with unstable monetary systems like Argentina.
Therefore, stablecoins emerge as a new option for investors who want to make a transaction via a global currency, providing access to all.
The adoption of stablecoins will support the capital market formation and present new opportunities for decentralized finance on the blockchain like derivatives markets and lending.
For instance, the introduction of stable coins can also offer decentralized cross-border lending. It overcomes the problems encountered due to high volatile cryptocurrencies, which creates the lending process uncertain because lenders and borrowers cannot plan for the future safely.
Ethereum and other cryptocurrencies proved their potential for global crowdfunding campaigns, but many of those projects faced issues as they had to manage financial plan because of the volatility in assets. With stable coins, inefficiencies can be removed from the cryptocurrencies by stabilizing its value.
Now, it is clear why do we need stablecoins; let’s understand some of its real-world applications.
Protection from local currency crashes
In case, the fiat currency crashes in value; local citizens can exchange the crashed money for EUR-backed, USD-backed, or asset-backed stablecoins before they lose their savings. In this way, people get protected from further drops in the value of the local currency.
For example, currently, Venezuela is facing hyperinflation. The prices of goods in that country have been doubling almost every week on average.
Annual inflation rate at the end of 2018 in Venezuela was 80,000%. Most of the citizens cannot even afford food as their savings became worthless and the value continued to drop with each passing day.
Stablecoins can offer an ideal solution to all such people by allowing them to exchange their dropped currency holdings with a stable currency.
A day-to-day currency
Stablecoins can be used like any other currency for day-to-day purposes. From buying morning coffee to transferring funds to the family, we can use a digital wallet to pay with stable coins.
The stable currency is especially beneficial for overseas payments, as there is no need to convert different fiat currencies. A person in China could receive USD-backed stablecoins without converting them into Yuan.
Simplifying P2P and recurring payments
Such automatic transactions are transparent, irreversible and traceable and therefore, are ideal for loan payments, salary, subscriptions and rent payments.
For example, an employer can deploy a smart contract that automatically transfers stable coins as a salary to employees at the end of the month. It is especially helpful for organizations that have employees all over the world. It will reduce the high fees and a long process of exchanging fiat currency from a bank account in New York to a European bank account.
With stable coins, this process could only take a few minutes and require a small fraction of transaction fees.
Enhanced cryptocurrency exchanges
There are only few cryptocurrency exchanges that support fiat cryptocurrencies because of strict regulations. However, the use of stablecoins allows exchanges to overcome this problem by offering crypto-fiat trading pairs.
Users can use USD-backed stablecoin instead of using actual dollars. It will lead to the increased adoption of cryptocurrency trading as the process of obtaining cryptocurrency becomes easier for newcomers. Also, they can think about trading in terms of dollars or stable assets rather than fluctuating values of cryptocurrencies like Bitcoin.
Quick and affordable remittances for migrant workers
Today, migrant workers send payments through platforms like Western Union to transfer money back to their loved ones and family. This complete process is quite expensive and slow due to which families lose a big chunk of funds due to high fees.
Though cryptocurrency is the best solution to this issue with low fees and fast transaction, a cryptocurrency such as Bitcoin can drop in value by 20-30% in just one or two days.
Stablecoins can be a better alternative to this problem as workers and their families can use digital wallets across the globe to transfer stablecoins instantly with low fees and no volatility.
- Tether (USDT)
Tether (USDT) is the first stablecoin which has been widely adopted and issued on the Bitcoin blockchain. Every unit of Tether is backed by a US dollar held in the Tether Limited Reserves. The company has even published their bank account and balance on the “transparency” page of their website.
USDT is also available to trade on most significant exchanges; however, it has seen a drop in market cap in recent weeks due to increased competition in the stablecoin space. It’s market cap still looks impressive with $1.7 billion.
- TrueUSD (TUSD)
It is a USD-backed ERC20 stablecoin which is completely collateralized, transparently verified and legally protected by third-party audits. Also, multiple escrow accounts can reduce risk and offer legal protection to token holders.
Using TrustToken’s smart contracts, TUSD ensures 1:1 parity. Though TrustToken framework provides the legitimacy of the process, it is least available than TrueUSD (TUSD).
- bitCNY (BITCNY)
bitCNY is a market-pegged asset based on the Chinese Yuan built on the Bitshares Blockchain. These stablecoins are also available in different versions, including bitEUR and bitUSD. Backed by the BTS, the minimum collateral for bitAssets is 2x. For example, you have to put BTS of $200 worth into the contract to borrow $100 bitUSD.
- USD Coin (USDC)
USD Coin is also one of the competing stablecoins in the market. It is an ERC 20 token, which is pegged 1-1 to the US dollar and has been launched by the CENTRE consortium and Circle.
Certified third parties audit their reserve accounts every month. After one month of its launch, USD Coin has gathered $132 million in market cap.
- DAI (DAI)
This stablecoin uses a unique approach to maintain its price. Unlike other currencies backed by fiat, it uses a system if collateralized debt position (CDP) smart contracts supported by Ethereum.
Using DAI, anyone across the world can select money they can place their confidence in. Since every DAI is backed by collateral at all times, you don’t have to worry about its value going up or down.
If you are looking to gain the trust of investors by creating a stablecoin backed by a stable asset or fiat currency, we can help you develop a secure and reliable stablecoin for you. Contact our Stable Coin Developers and discuss your requirements.
All information will be kept confidential.
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