We had all felt the gush of excitement when Bitcoin price was going bullish every single day in 2017 and were disheartened when it was crashing day after day in 2018. There is no doubt, the price of cryptocurrencies has witnessed quite a wild ride, and because of so much volatility, they are not suited to replace FIAT as yet.
While we can still adjust with price volatility, it is not great for regular payments. On a regular day when you buy a pizza for $10, you know the next day, the same pizza wouldn’t cost you $1 or $40. That’s the reason why across economies, FIAT currencies are used as payments to buy goods and services.
If we think from a broad perspective, it is not just about payments. While the industries especially the banking and finance are in the process to adopt blockchain, price stability becomes a fundamental requirement to shift traditional financial products like loans.
According to Bloomberg, Facebook is currently working on developing a stablecoin which will be pegged to the U.S. dollar. The stablecoin will allow users to transfer money on its WhatsApp messaging app and is rumored to be first use in India for remittance payments.
Types of stablecoins
The stablecoins developed so far are trying to achieve widespread adoption of cryptocurrencies without doing away with the characteristics of crypto. As of now, there are some stablecoins in the market, each trying to solve the price stability issues of cryptocurrencies. All of these coins broadly fall under one of the below-mentioned categories:
• Fiat collateralized
• Crypto collateralized
• Fiat-collateralized Stablecoins: These are the simplest form of stablecoins. A FIAT currency backs fiat collateralized stablecoins in the ratio of 1:1. E.g. you give the company developing stable $100, and in return, they give you 100 of their stablecoins. Now, whenever you wish to liquidate your stablecoins back into USD, you return the stablecoins, and the company will send you the USD.
The user investing in these stablecoins needs to establish a certain degree of trust in the issuing company as there are chances of fraud happening here. There isn’t much which can stop the company owners to run away with the funds or even entirely collateralizing the issued coins.
Tether (USDT) is one of the most famous examples of fiat collateralized stablecoin. Currently, it is the 9th largest cryptocurrency in terms of market capitalization.
Pros: Simple to understand
Cons: High-Risk Investment, Centralized in Nature
• Crypto-collateralized Stablecoins :As the name suggests, this category of stablecoins is pegged to other cryptocurrencies. However, as the price of the cryptocurrencies is only not stable, the coin developers use a set of protocols to make sure that the price of these stablecoins are maintained at $1. These set of protocols may differ from one stable coin to another. However, there are chances that they have a potential weakness which can make them risky.
Pros: Developed on the decentralized concept
Cons: Protocols may have a potential weakness
- Non-collateralized Stablecoins: This category of the stablecoins are not linked to any collateral. These work in the same fashion as the fiat currencies and are governed by a centralized agency like Bank. These are likely to work on the Seignorage Share scheme which was invented by Robert Sams. This scheme is based on a simple idea the smart contract needs to develop like a central bank which has just one monetary policy. This policy issues a currency that will trade at $1. Now by simply controlling the monetary supply, the smart contract can ensure that the stablecoin always trades close to the value of $1.
Pros: No Collateral Risk, work like FIAT
Cons: Less funds to maintain risk