What is meant by stable coin?
Digital currencies like the U.S. dollar or gold can be used as a “stable” reserve asset for a stable coin. Volatility can be reduced by using Stable coins instead of volatile cryptocurrencies like Bitcoin.
Cryptocurrency and traditional fiat currency can coexist under a stable coin because their prices are linked to a reserve asset like the dollar or gold. In comparison to something like Bitcoin, this drastically reduces volatility, resulting in a digital currency that is better suited for everyday commerce as well as transfers between exchanges.
The idea of combining the security of traditional assets with the adaptability of digital assets has proven to be a huge success. Stable coins like USD Coin (USDC) have attracted billions of dollars in worth since they’ve emerged as some of the most popular means of storing and trading value in the cryptocurrency ecosystem.
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Stable coins of Various Types
Because the US dollar is so widely accepted, some argue that stable coins are a solution in search of a problem. Those who believe in cryptocurrencies, on the other hand, see it as a form of digital cash that is free from the influence of governments or central banks. stable coins can be divided into three categories based on the mechanism that keeps their value stable.
Stable coins Backed by Fiat
With fiat currency (or currencies) as collateral, stable coins are guaranteed to be worth what they are worth since they have a reserve of a fiat currency (or currencies). Gold and silver, as well as crude oil, can be used as collateral for stable coins, however the majority of stable coins are backed by US dollars.
Independent custodians and frequent audits ensure that these reserves are safe and secure. As a result of their reliance on US dollars, stable coins such as Tether (USDT) and TrueUSD (TUSD) have become popular.
Stable coins Backed by Cryptocurrency
Stable coins backed by other cryptocurrencies are known as crypto-collateralized stable coins. Stable coins are over-collateralized, meaning that the value of the underlying cryptocurrency reserves exceeds the value of the stable coins themselves, due to the possibility of excessive volatility in the underlying cryptocurrency reserves.
Using a $2 million cryptocurrency as a reserve to issue $1 million in a crypto-backed stable coin insures against a 50% drop in the value of the reserve cryptocurrency. For example, MakerDAO’s Dai (DAI) stable coin is tied to the US dollar but backed by Ethereum (ETH) and other cryptocurrencies worth 150 percent of the DAI stable coin in circulation.
Stable coins Based on Algorithms
Stable coins that use algorithms to maintain their value may or may not have reserve assets. Keeping the stable coin’s value stable is the major differentiator between them. They use computer programs to control the supply of stable coins.
Central banks perform the same thing, although they use a reserve asset to help stabilize the value of the currency they issue. Central banks like the Federal Reserve, which are responsible for issuing legal money, have the ability to set monetary policy in a transparent manner based on well-known parameters.
In a crisis, algorithmic stable coin issuers have no recourse. In the early hours of May 11, 2022, the price of the Luna token used to peg the TerraUSD (UST) algorithmic stable coin dropped more than 80 percent, thus erasing its peg to the U.S. dollar.
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What are the benefits of using a stable coin?
In the case of the USDC stable coin, for example, the USDC is backed by dollar-denominated assets in segregated accounts with US-regulated financial institutions that are at least equivalent fair value to USDC in circulation. An independent accounting firm attests (i.e., publicly verifies) these accounts.
The USDC stable coin is now running on the Ethereum blockchain, like many other stable coins. While non-pegged cryptocurrencies can be volatile, stable coins can retain some of their most potent features:
- It is possible for anyone on the internet to access stable coins at any time of day or night.
- Transmitting them is simple and safe thanks to their speed, low cost, and security.
- They’re Internet-ready and can be programmed.
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What is the purpose of stable coins in the crypto market?
When it comes to using cryptocurrency for real-world transactions, the volatility of many of the most popular cryptocurrencies can make it difficult, if not impossible. Stable coins solve this problem.
According to Anthony Citrano, the founder of Acquicent, a marketplace for NFTs, “digital currencies like Bitcoin and Ethereum are tremendously volatile, making pricing things in their terms very difficult.” By tying their prices to a well-established reserve currency, stable coins avoid this problem.
Stable coins can also be used as a currency in a crypto brokerage because of their stability. To avoid the risk of losing their investment in Bitcoin, traders can use a stable coin like Tether. In contrast to the banking system, which is closed at night and on the weekends, stable coins are available around the clock.
If you’re interested in smart contracts, stable coins can also be used in conjunction with this type of electronic contract. When dealing with more volatile cryptocurrencies, the stability of the digital currency helps to avoid disagreements.
What can stable coins be used for?
Cryptocurrencies like Bitcoin and Ether have a tendency to fluctuate in value frequently, even by the minute. Buyers and sellers can have confidence that the value of their tokens will neither surge or fall unexpectedly in the near future if the asset is linked to a more stable currency.
- You don’t need a bank account to store stable coins, and they’re straightforward to transfer.
- As a result, Stable coins’ value can be transported over the world, even to countries where the US currency might not exist or where local currencies are unstable.
- Stable coin investments can earn interest that is often more than what a bank would pay.
- Millions of dollars worth of USDC have been transferred at fees of less than a dollar.
Stable coins like USDC, with their minimal transaction fees and quick processing times, are an excellent alternative for international money transfers.
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