What is a Stablecoin?

Elena Derymova
Mar 12 · 7 min read
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There are a few particular problems that make the public at large reluctant to adopt cryptocurrencies. Chief among them is the volatility, which certainly wasn’t helped by the freakish swings in bitcoin value that we’ve seen in 2017–18. Your average citizen isn’t going to be happy when they go to buy groceries and end up giving the store a coin that was worth $10 as they left home but grew to $50 right as they come back. The stability isn’t going to just magically anchor itself in bitcoin, so alternative options must be presented if the public is ever going to sway in favor of cryptocurrencies. And that’s where stablecoins come in, combining the relative stability of regular currencies with the security and innovation that cryptos bring to the table. Today, we’ll do a deeper look on the topic and discuss the pros and cons of stablecoins and see if the concept of a stable cryptocurrency has any merit.

A Coin By Any Other Name
What Is Stablecoin?

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Pretty much the only thing you need to know about stablecoins as a concept is in their name. Rooted by being collateralized in currencies, assets, or other crypto, this type of coin guarantees increased stability by hinging its value on its backing. That way users can expect at least a semblance of calmness in any stablecoin’s market with huge drops possible only if some major real-world changes occur. For example, a stablecoin that’s collateralized by the US dollar isn’t going to lose half its value in a day unless some major civil unrest sends the country into chaos. You can always expect a modicum of stability from the globally used currencies as the world hinges on them.

This stability will, of course, vary depending on what you choose as backing. With several types of stablecoin to choose from, you must be careful not to bank on the one that uses a volatile currency as its guarantee. However, even though it still requires analysis, the overall optics of buying into top stablecoins and using them on a global scale certainly seem a bit more promising than those of regular cryptocurrencies.

The Usual Suspects
The Types of Stablecoin

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There are three core types of stablecoins, namely the fiat-backed, the crypto-backed, and the non-backed. You might, understandably, wonder how a non-backed stablecoin would work after we’ve just talked about collateralization and we’ll explain it all in due time. First, let’s talked about the most popular in the list of stablecoins — fiat-backed.

Fiat-backed stablecoins rely on currencies or other valuable assets to guarantee their value, usually doing a 1:1 correlation. The most popular choice is, of course, the US dollar as even the most famous stablecoin — Tether — uses it to collateralize its value. That kind of backing provides substantial stability that makes users much more eager to buy the coin and use it regularly. However, these lose some of the cryptocurrencies’ much-touted decentralization and can only take off if the public at large trusts the company that provides the backing. Basically, if an untrustworthy bank tries to offer a stablecoin using its funds as backing, quite a few people will be hesitant to buy in. Thus, you could consider fiat-backed stablecoins to be reliant both on the currency or asset and the reputation of the asset holder, which adds just a bit more chaos into the mix.

Crypto-backed stablecoins are a bit of an unusual choice since they’re, by definition, reliant on other cryptocurrencies which can be quite volatile. This would defeat the purpose of a stablecoin if not for one important distinction: the value isn’t collateralized 1:1. Instead, it’s customary to bank a single stablecoin versus several coins of a cryptocurrency of choice. That way the value of the stablecoin should stay above the acceptable level even if the backing crypto falls into a mercurial period where it loses a chunk of its value and then regains some etc. It’s not the most reliable option for stablecoins but it’s the one that manages to preserve some decentralization and is thus more likely to find favor among crypto purists.

Non-backed stablecoins, as strange as the concept may seem, are a very interesting case. First and foremost, they are winning over crypto users by offering both stability and decentralization and independence. It’s the kind of combination that can help cryptocurrencies spread without losing the philosophy that made them prominent in the first place. These coins use smart contracts to regulate the number of available coins, adjusting the supply according to the increases and dips in value. That way the stablecoin price can stay close to a certain desired level that’s established at the coin’s conception. Should the smart contracts buy up too many of the coins, the users typically receive shares that entitle them to future profits. Thanks to that it’s unlikely that you lose big when dealing with non-backed crypto stablecoins.

It’s A Wonderful Coin
The Advantages of Stablecoin

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As we’ve already established, stablecoins are winning over people thanks to their promise of a more stable cryptocurrency option. With backing that keeps them from plummeting overnight, these are the safe bets in the crypto market. But that’s not the sole advantage of stablecoins as they also offer a wider appeal, which means that they’re more likely to root themselves in the society as a whole. This, consequently, means that it’s less of a danger for investors and early adopters, who can, pretty reasonably, assume that the money they put into the coin isn’t just going to disappear.

Once the public learns about a particular stablecoin, it’s easier to spread it and its influence because it has a tangible asset behind it. Your average user will find it easier to trust a coin that’s the digital equivalent of a dollar (an obviously simplified way of looking at things but it’s a good pitch for non-adopters) than some ephemeral digital coin. Having this anchoring element turns stablecoins from a strange new tech to something that even your grandma could use. This does have the chance of killing the hype off a bit since few young tech disrupters will be eager to share their currency of choice with the older generation, because that’s just not cool enough. But, let’s be honest, hype hasn’t being doing a bang-up job of sustaining other cryptos so far.

Plus, let’s not forget that stablecoins are a more suitable solution for quick transactions than options such as Bitcoin and its counterparts. The stable price, the fast turnaround, and sped-up processing make it viable for paying for your groceries or ordering pizza. Rooting stablecoins in daily life and making them work for the user is the primary way of capturing the market’s attention and it’s working quite well so far.

Every Coin Has Its Thorns
The Problems of Stablecoin

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Now, despite being a promising development in the crypto market, stablecoin comes with some baggage. There’s no avoiding the fact that many top stablecoins abandon decentralization in favor of that same stability that makes people covet them. This, in and of itself, goes against the initial philosophy of cryptocurrencies and puts the market in danger of being monopolized or cornered.

Admittedly, some options are pushing for decentralization and trying to preserve the ideas of crypto founders. However, those are faced with the problem of finding good backing. Basically, if you rely on a bank to do collateralization, you can expect stability in the value but then you’d be sacrificing the decentralization. Similarly, crypto-backed stablecoins are non-centralized but they have to give a little ground in terms of stability. It’s always a balancing act and not every company can manage that.

Plus, crypto-backed stablecoins are kind of a difficult sell, especially for the masses. “It’s a cryptocurrency that relies on another cryptocurrency but it’s totally stable, I swear” isn’t a great pitch if you want to instill confidence in stablecoin. There’s still some road left to cover before crypto-backed options can be easily understood and accepted by most.

Last but not least, let’s not forget that a crash in the backing currency or asset might be less likely than one in the crypto market but it’s still possible. Historically, the cases of countrywide dips in currency value have happened all over the world so stablecoins aren’t, strictly speaking, immune. However, you can usually spot this kind of crash well in advance if you have analytics on your side. Just remember that stablecoins aren’t magically guaranteed to stay steady forever and you should be fine.

Steady As She Goes

As you can see, stablecoins are a highly promising aspect of the crypto market but there’s still some work left to be done before we can announce a takeover from them. Still, the idea has some longevity if done properly and we’re going to keep our hands on the pulse. Hopefully, there are many exciting developments to come. And if you want to learn more about the crypto market or blockchain in general don’t hesitate to follow me for more news and expertise! My team at Incode Group knows enough about the technology to help with any issues you might have.

Elena Derymova

Written by

Head of Blockchain Department at Incode Group http://bit.ly/incodeblockchain