Complete guide to Stablecoins [Updated]
Key highlights of Guide to Stablecoins
- What are stablecoins and how they are different from traditional cryptocurrencies
- 4 major types of stablecoins in the market
- How stablecoins have changed the Fintech industry
Launched in 2008, Bitcoin gave us a new perspective on payments and trading. Since then, hundreds of cryptocurrencies have been launched in the market which people can use to buy assets, make global transactions, or buy a cup of coffee at your favourite restaurant. However, it is still uncommon to see purchasing a dress or paying at a restaurant with cryptocurrencies. It is majorly due to its high volatility of cryptocurrencies. Stablecoin is an attempt towards price-stable cryptocurrency as it is backed by an asset such as dollar or gold.
Stablecoins, on the other hand, have been gaining a lot of traction as they are secure, low cost, and, most importantly, price stable. They often represent real money like dollars or pounds, which makes them a go-to option for the masses. However, the question remains — Can stablecoins lead to mass adoption of digital currencies? Let’s find out!
Introduction to Stablecoins
In this guide to stablecoins, we will discuss what stablecoins are and why do we need them. We will also explore their advantages and disadvantages to understand whether they are better than traditional cryptocurrencies.
What are Stablecoins?
Stablecoins are digital currencies that are pegged or backed by assets such as fiat currencies or gold to gain a stable value. They aim to offer the best of both worlds — high speed and security of cryptocurrencies and stability of fiat currencies. Stablecoins provide numerous benefits of cryptocurrencies, such as:
- High security with cryptography, encryption, and hashing
- Ability to transfer value in a peer to peer fashion
- Real-time transactions
Talking about the list of stablecoins, more than 200 stablecoins have been announced, with 30% of them being active, 60% are still conducting R&D, and 10% have been discontinued. With stablecoins gaining tremendous growth in the year 2020, the total supply of the stablecoin market has reached 12 billion.
“In June 2020, the amount of value transferred using stablecoins exceeded the amount transferred using BTC for the first time.”
Let’s also take a look at some of the popular ones in the list of stablecoins.
Tether — With more than a $10 billion market cap, Tether is the biggest and one of the first stablecoins in the market. The coin is backed by the US dollar and maintains a 1:1 ratio in terms of value.
The market cap of tether, the world’s largest stablecoin, passed the $50 billion mark on 23rd April 2021.
USD Coin — USD Coin is a popular stablecoin launched by the CENTRE consortium, Coinbase, and Circle. Like Tether, USD Coin is also pegged to the US Dollar in a 1:1 ratio. It is based on the Ethereum blockchain, enabling fast and secure transfer of value at very little cost.
Paxos Standard — Paxos Standard or Pax is one of the most quickly adopted stablecoin and has been approved by the New York State Department of Financial Services. It is also backed by the US Dollar in a 1:1 ratio. When the coin is redeemed for the USD, the tokens are destroyed.
TrueUSD — TrueUSD is another US Dollar backed stablecoin with around $1.8 million in reserve. It is considered one of the most reliable and proven stablecoins in the market.
Dai — Dai is a popular decentralized stablecoin developed by Maker. That means the coin is governed by the community Maker token holders. 1 Dai is equal to 1 US Dollar. Dai coin has been integrated with over 400 apps and services.
You can check the complete list of stablecoins here.
How do stablecoins work?
Stablecoins aim for stability in value. This means that the value of these coins should not fluctuate frequently, like other cryptocurrencies such as Bitcoin. Stablecoins like USDT and Tether are backed by fiat currencies and generally require a custodian to regulate the currency and maintain the fiat reserve. The problem with these coins is that they rely on the honesty of the issuing party in honouring deposits and withdrawal as they should.
Some stablecoins like Dai are decentralized coins that are stabilized by the supply and demand forces. They are not issued by any centralized organization, the company itself does not have control over its value. They use smart contracts to manage the collateral and maintain order.
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Stablecoin advantages to Fintech
Stablecoins offer a number of benefits to its users and the Fintech industry. Some of the popular stablecoin advantages are mentioned below -
Based on Blockchain
Stablecoins like just another cryptocurrency are based on blockchain technology. This brings the core benefits of blockchain to the masses that are better security, transparency, and accountability.
Faster and cheaper remittance
Stablecoins offer a quicker, cheaper, and more secure mode of cross-border payments or remittance compared to current systems that are plagued with a slow and expensive network. Price stability adds to the benefits of cryptocurrencies.
dApps
Stablecoins can be integrated with applications and services for in-app purchases and other payments in the dApps ecosystem.
Reducing price volatility
Stablecoins offer all the benefits of a cryptocurrency while eliminating the high price volatility. Therefore, most of the coins are backed by fiat currencies or precious metals such as gold.
Benefits of both worlds
Stablecoins offer high speed and security of cryptocurrencies and stability and simplicity of fiat currencies.
Types of Stablecoins?
There are mainly four types of stablecoins with regards to the kind of collateral they are backed by.
Fiat-collateralized stablecoins
This is the most common type of stablecoin that exists today. These types of coins are fully backed by fiat currencies like USD and GBP in a 1:1 ratio. That means, for each such stablecoin, the company reserves 1 USD or GBP as collateral.
Popular examples for fiat collateralized stablecoins are Tether and TrueUSD.
Commodity-collateralized stablecoins
Commodity-collateralized stablecoins work almost similar to fiat-based stablecoins. The main difference between the two is that the former is backed by precious metals such as gold, silver, or other commodities.
Popular examples for commodity-collateralized stablecoins are Digix and HelloGold
Crypto-collateralized stablecoins
As the name suggests, these types of stablecoins are backed by a cryptocurrency. Although it defies the purpose of stablecoins because of the volatile nature of cryptocurrencies, a vast reserve is kept to cover the large price swings. This also means that the peg ratio is not 1:1 in the case of fiat-backed coins; two or three tokens are reserved for every stablecoin.
Popular examples for commodity-collateralized stablecoins are BitUSD and Dai.
Non-collateralized or Seigniorage-style stablecoins
This type of stablecoins is not backed by any asset but depends on complex sets of algorithms that buy and sell stablecoins automatically to maintain their price stability.
Popular examples of non-collateralized stablecoins are Ampleforth (AMPL), Carbon and Kowala kUSD.
A new kind of stablecoins was introduced recently which utilizes
Fractional Algorithmic Stablecoins or Hybrid Stablecoins
They are the newest type of stablecoins which are partially backed by collateral and partially stabilized algorithmically. The price of such stablecoins is supported by a flexible collateral mix consisting of other stablecoins and a separate ‘seigniorage token’.
A popular example of fractional algorithmic or hybrid stablecoins Frax (FRAX).
Stablecoins getting bigger
Stablecoins market has witnessed explosive growth in the year 2020. While it took five years for the market to reach a supply of 6 billion, it took just four months, from March to July, for that supply to reach the 12 billion mark.
According to CoinMetrics, many stablecoins, including USDC, Paxos Standard, Gemini Dollar, Tether, and the Binance Dollar, registered staggering numbers in terms of percentage growth of the total market cap.
USDC notably witnessed a 700% rise in growth in Q1 of 2020. Jeremy Allaire, CEO at Circle, said, “We have seen explosive interest and growth in USDC.” He also added, “There is clearly very significant global demand for digital dollars, and the use of digital dollars as a new payment medium.”
Update — After the rise in market cap in 2020, stablecoins witnessed a staggering rise in market cap in 2021. The largest stablecoins by far are fiat-collateralized stablecoins such as Tether, USDC and BUSD. Five of the six stablecoins included in the graph are fiat-backed stablecoins.
Central Bank Digital Currencies (CBDCs)
The emergence of stablecoins also paved the way for governments and central banks to explore decentralized technology. CBDCs or Central Bank Digital Currencies have the potential to bring financial inclusion, improved transparency, and traceability. Many countries are currently exploring technology to launch their own digital currencies.
- People’s Bank of China recently announced that they are working on Digital Yuan. Pilot tests are being carried out, but no launch date has been announced yet.
- Digital Dollar has also been gaining traction lately. US lawmakers introduced a bill proposing a Digital Dollar (a CBDC) as a mode to send stimulus payments to the citizens.
- The Bank of England has also published a discussion paper on CBDCs, indicating their efforts towards leveraging digital payments through technology.
Read more: CBDCs changing the payment landscape
Facebook’s Libra
Facebook has been in the race for the past couple of years for launching a digital currency that is stable, fast, and secure. Their aim saw the light of the day when they announced Libra — a cryptocurrency by Facebook backed by a ‘bucket’ of securities and currencies. The coin is poised to change the way we make payments by offering instant money transfer through a messaging app with low or no charges.
When announced, several companies, including Uber, Visa, MasterCard, PayPal, and others, were ready to invest in Facebook’s digital coin. However, several of them took a step back as central banks and regulators feared that Libra is going to destabilize monetary policies, enable money laundering as well as jeopardize user’s privacy. You can read more here.
Now known as Diem, the Facebook-backed digital coin is expected to launch later this year, albeit in a much more limited form.
The future of Stablecoins
The Fintech sector is developing at a rapid pace with more advanced and digital modes of payments. Stablecoins can play a critical role in enabling quick and secure digital payments while maintaining their price value through tough times, such as the current pandemic. It also opens the door to the mainstream adoption of cryptocurrencies in everyday life. While we believe that stablecoins can be a solution to modern financial problems, it is still hard to predict its future. One thing is for sure, stablecoins are a significant step towards embracing digital currencies.
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