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What is Stablecoin?

Fleta | 01.12| 584

After introducing Bitcoin 10 years ago, we started to see many altcoins in the market, including Ethereum. There are thousands of these coins currently registered with Coinmarketcap.

At some point, many of us would have imagined how much money we would have if we had bought $ 1,000 worth Bitcoin at the right time. This is because Bitcoin, even Ethereum, fluctuates with the price of assets entirely left to market supply and demand.

These unstable coins may experience up and down in prices, as any central authority does not govern them and because they are not official state money. So, is there a safe escape ramp to prevent this volatility, and how does it work?

What are Stablecoins?

Stablecoins are cryptocurrencies that are often expressed in dollars. Thanks to these dollar-indexed coins, you can maximize your chances of protection from market fluctuations or risks.

Let’s quickly look at some popular Stablecoins:

  • Tether (USDT)
  • USD Coin (USDC)
  • True USD (TUSD)
  • MakerDAO (DAI)
  • Paxos Standard (PAX)
  • Gemini Dollar (GUSD)

How do Stablecoins affect cryptocurrency prices?

Cryptocurrencies are not affiliated with any government or firm. They are also not bound by political, social, and other economic indicators. These currencies, which depend entirely on supply and demand in the market, can be quite volatile.

This volatility is both a driver and result of the lack of public (whether institutional or individual) trust in cryptocurrency as a reliable and balanced currency option. Poor and undefined regulation also plays a role in adding to this distrust. People are disconcerted by the lack of a structured framework to guide the adoption of crypto and therefore view it as a speculative investment.

Given high levels of distrust in cryptocurrencies, investors tend to resort to safer options like Stablecoins.

Sadly, half of the world’s wealth now in the hands of 1% of the population. The cryptocurrency world’s situation is not much different — 448 people own 20% of all Bitcoins. These people, called Whales, play an active role in influencing the prices of cryptocurrencies. If these people want to convert their crypto assets into Stablecoins, the price of cryptocurrencies enters a downward trend or vice versa. That is why the price of cryptocurrencies is highly dependent on whales, and therefore on Stablecoins.

How do Stablecoins work?

Stablecoin is a cryptocurrency with a fixed value. This means that the value of the cryptocurrency should not frequently fluctuate, as in standard crypto assets. Although this fixed price range is often tied to the US dollar, there are also currencies fixed to different price indices. Some Stablecoins, which are just getting ready to enter the market, aim to be fixed to the consumer price index or similar indices of some countries. Since Stablecoins can be fixed to almost anything, in theory, there are Stablecoins fixed to multiple fiat coins and even to precious items like gold or silver.

The decisive factor for Stablecoins is how the latch is maintained and what the whole system is based on. In other words, how does the coin organizer preserve the value of the currency?

Some central Stablecoins, such as Tether, require a custodian to regulate the currency and reserve a certain amount of collateral. Tether holds the US dollar in a bank account, and the amount held must be equal to what they issue to maintain the order of the system. In this way, price fluctuations are prevented.

However, other stable decentralized cryptocurrencies, such as Dai, achieve this goal without a central authority figure. They use smart contracts on the Ethereum blockchain to manage the collateral and maintain order.

Three types of Stablecoins

Based on the design, we can split Stablecoins into three significant types:

  • Fiat-collateralized
  • Crypto-collateralized
  • Non-collateralized

Fiat-collateralized

It is the simplest version, with every Stablecoin currency produced in that currency. Production and liquidation of the coin are carried out by the issuer of the coin. This system is similar to the age-old practice of “used amount of gold that should be kept in the central bank’s safe for every dollar printed”.

Price remains stable because if you can buy the coin for less than $1, you can exchange it with the issuer for $1 and vice versa. The only problem is that it relies on the issuing party being properly regulated and honoring deposits and withdrawal as they should.

Well-known Fiat-collateralized Stablecoins:

  • Tether ( USDT)
  • True USD (TUSD)
  • Gemini Dollar (GUSD)
  • Paxos Standard (PAX)
  • USD Coin (USDC)

Crypto-collateralized

As the name suggests, this version uses other cryptocurrencies (e.g., ETH) as collateral for the Stablecoins. However, because the crypto values themselves are not stable, these Stablecoins need to use a set of protocols to ensure that the price of the Stablecoin issued remains at $1.

Let’s say we deposit $200 of ETH to receive $100 of a Stablecoin in return. The Stablecoins are now 200% collateralized. If Ether drops by 25%, the Stablecoins can still keep its price stable as there are still $150 worth in ETH collateral backing the value of the Stablecoin.

Well-known Crypto-Collateralized Stablecoins

  • MakerDAO (DAI)

Conclusion

Although Stablecoins seems to be a safe escape point by many, the damage to cryptocurrencies also needs to be considered. This is because, especially when large whales move down the market, they can secure a significant blow to the price of cryptocurrencies while ensuring themselves to Stablecoin. Therefore, we cannot say that there is a definite consensus on the existence of Stablecoins.

But we have to say that Stablecoins exist in the market and have created a severe volume. It is unknown how Stablecoins affect the market, but their presence seems necessary for the ecosystem’s continuity.

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What is Stablecoin? was originally published in FLETA on Medium, where people are continuing the conversation by highlighting and responding to this story.

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