A Deeper Look at Stablecoins: What They Are and Their Benefits

Mainfinex
Mainfinex
Aug 26, 2019 · 8 min read

Even those who are familiar with cryptocurrencies may not be familiar with stablecoins. These are a type of cryptocurrency designed to reduce price fluctuations. The simplest explanation of a stablecoin is a type of crypto with a value pegged to that of another asset, like fiat.

Stablecoins Can Be Pegged to Any Asset

When most people think of stablecoins, they imagine a coin connected to the value of fiat, such as the U.S. dollar. While this is the most common situation, a stablecoin can technically be pegged to any asset. This means you could create a stablecoin pegged to precious metals, other cryptocurrencies, or some combination of these assets.

The goal of a stablecoin is that it will always be worth one of the assets backing it. For example, a stablecoin pegged to the U.S. dollar would have its value hover around $1.

Stablecoins Let You Use Fiat Like Crypto

Because stablecoins are pegged to fiat currency, they essentially let you use that fiat as you would crypto. This makes it possible to easily invest USD on crypto exchanges. At the very least, it puts the values of cryptocurrencies in perspective for those unfamiliar with crypto prices. This occurs by comparing crypto value to that of a fiat that most know.

For example, if an exchange does not have support for fiat, it could still support Tether or another stablecoin. You could then look at the rates and trends for Tether, including comparing it with other cryptocurrencies. This would provide insight into the U.S. dollar since Tether and the USD have the same price movements.

Stablecoins Have Fast, Affordable Transactions

For those who want to think about funds in terms of fiat, stablecoins offer a great method of achieving quick and affordable transactions of fiat-like assets. You get the speed and low transaction fees associated with cryptocurrencies. At the same time, you know that the value of the stablecoin will be the same as that of the fiat in question.

As an example, consider two people who have both Tether (USDT) and U.S. dollars. They want to send money to each other and will do so using both methods. Sending U.S. dollars between accounts will take at least a day and may come with high transaction fees. The transaction time and cost will increase further if the bank accounts are in two different countries. By contrast, transactions between two Tether wallets will be incredibly cheap and nearly instant.

Since Tether is backed by U.S. dollars as collateral, either party could easily exchange their Tether for U.S. dollars or vice versa. This means it would even be possible for someone to convert their fiat to a stablecoin, send the funds as that coin to a recipient, and then have the recipient convert the stablecoin back to fiat. This would have some additional steps but could save in transaction fees.

Stablecoins Overcome Volatility

The biggest advantage of stablecoins is their ability to overcome the volatility associated with cryptocurrencies. This volatility is among the largest criticisms of cryptocurrencies since cryptocurrencies can be extremely volatile. By pegging stablecoins to the value of a significantly less volatile asset, it becomes possible to minimize that volatility.

That lack of volatility is crucial for the adoption of cryptocurrencies. After all, no one wants to receive their paycheck or pay for items using a currency without stability. The amount you earn or something costs can change dramatically each day. Loans could also become pointless. By controlling volatility, stablecoins can overcome those challenges, helping to encourage the spread of cryptocurrency.

Volatility Solidifies Crypto as a Speculative Asset

While cryptocurrencies remain volatile, people are more likely to view them as speculative assets. This puts it in the same category as gambling and discourages the adoption of cryptocurrency as a means of value and for use in transactions. By preventing volatility, you can encourage crypto to be used as a medium of exchange. This also facilitates defining prices of goods and services in terms of crypto, something which is essential for adoption.

Stablecoins Have Collateral

As a general rule of thumb, most stablecoins will have the backing of collateral. This comes in the form of assets held in reserve. For example, if a cryptocurrency has a million coins pegged to the USD in circulation, it would need to have a minimum of $1 million USD in the bank.

How Stablecoins Maintain Their Value

Saying that a stablecoin copies the value of an underlying asset is one thing but understanding how to achieve this is another. It can be somewhat complicated to maintain the value of a stablecoin at the desired 1:1 ratio with a stable asset.

With Fiat as Collateral

One major type of stablecoin has fiat as its collateral. The stablecoin’s developers will keep $1 in the given fiat currency for every stablecoin that they issue. This ensures that users of the stablecoin can easily swap their crypto for fiat whenever they want, without the fiat running out.

It is important to note that this method of stablecoins is straightforward but does require a custodian. That custodian will have to guarantee that the stablecoins are issued properly and redeemable. Regular audits will also be required.

Stablecoins that use silver, oil, gold, or other assets as collateral would function in the same way.

With Crypto as Collateral

The idea of using cryptocurrency as collateral for a stablecoin may seem odd at first. After all, this does not necessarily overcome volatility in the same way. To make up for that, stablecoin providers can “overcollateralize.” In other words, they store $2 of cryptocurrency for each $1 in stablecoins.

Using cryptocurrency as collateral for stablecoins appeals to those who want to keep crypto decentralized. After all, the stablecoin’s value does not depend on fiat with a central government. The downside is that this “overcollateralization” requires incredibly large quantities of funding to get started.

There is always a risk with this method of a black swan event. In that situation, the underlying asset becomes worthless. That would cause the stablecoin to follow suit and also become worthless, even with overcollateralization.

Stablecoins Without Collateral

Some stablecoins do not actually have collaterals. These assets will use smart contracts in a similar manner to a reserve bank. Those smart contracts will monitor the demand and supply of the coin. When the prices get too low, the smart contracts buy coins in circulation to reduce supply. When the prices get too high, the smart contracts issue new coins.

Hybrid Stablecoins

There can also be hybrid stablecoins, which combine at least two of the above three types. These are algorithmically modeled as well as asset modeled. Hybrid stablecoins have the advantages from each category, offering the most benefits. They are also diverse enough to meet the varying needs of users.

The downside is that hybrid stablecoins can be more complicated, making them even harder to understand. They may also face restrictions from regulations or laws that would not affect stablecoins that fit just one of the above categories.

Stablecoins Reduce Uncertainty

The biggest draw of stablecoins is their ability to reduce uncertainty for users. Essentially, stablecoins let you take advantage of cryptocurrencies without having to worry about volatility.

Stablecoins also provide people with a safe, stable place to store assets. Those with stablecoins know that it is fast and easy to convert other crypto investments into stablecoins if there is some uncertainty. This way, they can keep their funds in crypto without worrying about a sudden drop in value. Furthermore, conversions between crypto are frequently cheaper than those between fiat and crypto. This lets users preserve more of the investment.

Stablecoins Can Help Unbanked Businesses

Stablecoins can also have applications for businesses and people who are unbanked. In this case, the people and companies involved can typically only conduct transactions in the local currency. But what happens if that local currency is unstable or not widely available outside of the area? With a stablecoin, a business or person can easily accept a stable currency, including accepting international payments.

Stablecoins Are Easier for the Public to Understand

There is also the fact that a stablecoin is simpler for the average person to understand than a cryptocurrency. There is no need for someone to take time to look up the value of Bitcoin at the moment or try to make sense of fluctuations. Instead, they get to use crypto in terms of a fiat that they are familiar with.

Examples of Stablecoins

Stablecoins are growing in popularity, with many examples already in existence and more on the way.

Tether (USDT)

Tether is probably the best-known stablecoin. It is pegged to the United States Dollar. This stablecoin has a simple concept but has faced doubts and criticism and is centralized.

Basecoin

Basecoin is a stablecoin without collateral. It expands the coin supply via consensus. It does not need collateral but does require faith in the protocol.

MakerDAO

This stablecoin is complex but has no dependence on fiat at all. The Dai coins are each worth $1 USD and smart contracts follow a complex system to maintain that stability.

TrueUSD (TUSD)

TrueUSD focuses on privacy but is centralized. This coin is fully collateralized, but unlike tether, it has transparent auditing and legal protection, including a full legal framework.

Other Stablecoins

To provide an idea of how many stablecoins exist or are in development, all the following are also stablecoins:

  • Arccy
  • • Augmint
  • • BitShares
  • • Carbon
  • • Facebook Libra
  • • Fragments
  • • Gemini Dollar (GUSD)
  • • Globcoin
  • • Havven
  • • Kowala
  • • Stably
  • • Sweetbridge
  • • USD Coin from Circle and Coinbase (USDC)
  • • X8X

Problems With Stablecoins

As with any other asset, stablecoins are not free from controversies and criticisms. Tether alone has faced several controversies. Academics claimed that during the 2017 crypto boom, Tether manipulated cryptocurrency prices. In fact, the researchers even indicated that half of the high December Bitcoin price was thanks to Tether.

Tether has also faced doubts about the quantities of collateral in reserve. If this had been true, it would have brought into question whether people could trust Tether, including its ability to convert USDT into fiat. Tether had an organization conduct an unofficial audit to allay these concerns.

Stablecoins May Undermine Cryptocurrencies

Some critics of stablecoins express concerns that they undermine other cryptocurrencies. This argument says that cryptocurrencies have worked hard to create an economy and develop their value. By contrast, stablecoins can just enter the space and automatically have value based on an existing fiat or another asset.

Centralization

These same critics also sometimes cast doubts as to how decentralized stablecoins can be, given that they are pegged to centralized fiats. Tether, for example, relies somewhat on the United States’ banking system since it is pegged to the USD. As such, Tether relies on the country’s centralized banking infrastructure, at least to some extent. Certain stablecoins, like Equilibrium, are getting around this criticism with overcollateralization.

Fiat Can Also Fluctuate

There is criticism that pegging cryptocurrency to fiat will not necessarily provide stability since fiat is not always stable either. After all, the U.S. dollar goes through inflation and experiences volatile exchange rates at times.

National Legal Tender Law

Some legal experts have concerns about pegging cryptocurrency fully to any fiat, such as USD for legal reasons. Specifically, regulators may view this type of fully pegged stablecoin as a USD derivative. In that situation, it would have to follow the national legal tender law.

Some Want Stablecoin Standards

Some advocates for stablecoins argue in favor of creating open standards for stablecoins that companies should implement. This would allow for improved self-governance and that should give users of stablecoins peace of mind. It should also help tokenize the world’s economy and increase the appeal of the crypto industry.

Lack of Financial Gain

Yet, others feel that the lack of volatility associated with stablecoins is an inconvenience. Specifically, they argue that the nature of stablecoins means that they do not offer many opportunities for financial gain.

Conclusion

Stablecoins combine many of the benefits of cryptocurrencies with the stability of fiat. There are numerous stablecoins already in existence, with more to come in the future. Time will tell if stablecoins are the key to mainstream adoption of crypto.

Welcome to a place where words matter. On Medium, smart voices and original ideas take center stage - with no ads in sight. Watch
Follow all the topics you care about, and we’ll deliver the best stories for you to your homepage and inbox. Explore
Get unlimited access to the best stories on Medium — and support writers while you’re at it. Just $5/month. Upgrade