How Do Stable Coins Work?
Price Stability of the Currency
In 1971, the president of the United States, Richard Nixon, repealed the gold standard to the U.S. Dollar. The new order said that there was no form of the backed asset which, like the U.S. dollar, could be used in the buying and selling processes. The absence of intrinsic value is the problem of all currencies.
In terms of cryptocurrencies, many people think that the main disadvantage is price volatility. Cryptocurrencies like Bitcoin, Ripple, and Ethereum are absolutely volatile.
To make a cryptocurrency for everyday use, each asset needs to have a stable value. Cryptocurrencies should be developed and have a functional stable asset, to be adopted by ordinary people and circulate worldwide.
You see, price and value stability is a weakness both for fiat currency and cryptocurrency. Price stability offers a stable cryptocurrency with which one can use different tools or products that require a low volatility asset for functionality.
And the next question: is there any possibility to do the same with the cryptocurrency space, and set a value to each asset?
Nothing has changed. People still hear a lot about the inability of today’s banks to hold a specific amount of money that users want to deposit. Banks still provide loans for debtors and just move money across users’ accounts.
However, if customers started to demand their money at the same time, the bank definitely wouldn’t be able to fulfill the requests of all of them. As a result, banks would collapse.
So, What to Do?
Blockchain has a solution and offers its spectacular suggestions to overcome the volatility challenge.
A futures contract is a contract that allows the buying and selling of an asset (a stock, gold, oil, or a currency) on a public exchange, and sets a stable price on it regardless of the date of purchase.
This type of contract is especially suitable when locking in a guaranteed price for a product. It also allows transferring possession of a product under a contract.
Another example of a method for locking the price of cryptocurrency is a service called “freezing,” or Lock Account, which was developed by Coinapult. This method does not require dealing with an exchange or a future contract. In essence, this service provides its users with the ability to fix the price of the Bitcoin they hold in their wallets in one of five assets: dollar, euro, pound, silver, or gold.
For example, if someone puts Bitcoin into his or her lock-account in an amount equivalent to $100 or 1 gram of gold, Coinapult undertakes to keep the set price, regardless of the price changes of the cryptocurrency, the U.S. dollar, or the gold.
However, every technology has a trick, and lock-account is no exception. If a user leaves his/her lock-account and the recipient’s wallet can’t implement the lock function, this means that this wallet can’t maintain a fixed price. So the asset that the user is going to buy or sell now becomes a regular token with a free-floating rate.
On the other hand, the lock-account service offers to save the fixed price of the cryptocurrency in national currency or precious metal. But it is not a cryptocurrency as well as a future contract.
Can we avoid losing the asset’s fixed price? Obviously, yes! Cryptocurrency can cost a fixed amount of fiat currency if it’s totally secured.
What Does Stable Coin Mean?
By the term stable coin, we mean to describe a cryptocurrency that has a stable value. The price for a stable asset is ascertained and set in the current rate for a fiat currency, like USD, EUR, or JPY.
Stable coins provide the most advantageous scenario for cryptocurrency and futures. The main difference between them lies in the fact that futures are fixed-term contracts, and cryptocurrencies are indefinite.
Every stable coin includes a specific set of mechanisms that mostly behave in the same way. In general, stable coins keep collateral of the asset and manage the supply. In this way, they incentivize the market, which allows trade of the coin for no more or less than $1.
Traditionally, a stable coin is backed by a reserve, which is based on the total number of circulated coins. The reserve includes different types of assets with a set price.
On the other hand, this does not help preclude speculation on exchanges because of investor sentiment and intention to establish strong pressure on supply or demand. That’s why stable coins should provide mechanisms required to handle market manipulations.
Mostly, stable coins can be developed by:
- A central authority. The higher the value of the collateral, the more coins are created. Consider that in this case, the transparency level will be lower.
- DAO provides the ability to issue fully decentralized and autonomous stable coins.
Yes, stable coins allow the transition to the dollar quickly and increase the liquidity of assets; however, they also add volatility to the cryptocurrency market, as they are vulnerable to speculation.
It is also important to say that stable coins require the trust of third parties, as most exchanges are centralized. Stable coins have their own tendency to be overly centralized, but there comes the need to establish a means to control the assets in order to provide their price and value stability.
A centralized system needs the trust of a third party, but we all know that blockchain excludes third parties, so this goes against the concept of cryptocurrency. It is not a huge problem, but it is definitely worth considering.
Did you know that stable coins have 1.5% of the total market cap of all cryptocurrencies, which is approximately $3 billion? Moreover, are you probably aware that they’re listed on over 50 of the most popular exchanges, while Tether is the most popular stable coin?
There are a lot of different stable coins in circulation today.
Let’s examine the top 5 stable coins that look the most promising among other coins and have the biggest potential for success.
Tether holds the leading position among other stable coins and has reached more than $2.7 billion in market capitalization. Price stability is possible through equal correlation between fiat currency (USD) and the Tether coin.
Besides the advantages for Tether, there are also a lot of detractors who want to enrich themselves at the expense of others. Tether has been said to experience many instances of speculation because of the lack of transparency. The problem lies in the absence of making public any audited reports that prove the funds the user has in reserve.
Another problem that has caused investors to stay away from Tether is the platform’s refusal to convert USDT to USD. In any case, Tether is still an obvious leader despite all of its cons and continues to increase its number of customers.
TrueCoin is a fully transparent and regularly financially audited stable coin that allows the exchange of the asset for USD. Moreover, this cryptocurrency offers use of the euro and yen, and it may incorporate gold and silver as a currency. TrueCoin looks like a really promising blockchain game-player and has implemented steps to make itself stand out from other players.
MakerDAO is as stable in relation to the U.S. dollar as Tether. Also, MarkerDAO is supported by Ethereum. The Dai coin, presented by MarkerDao, is pegged at $1 USD. However, MarkerDao does not support fiat currency, and for this, it often gets negative feedback from other stable coins.
Havven is the first totally decentralized platform for making payments. This project follows an autonomous method for reaching volatility. It offers a dual-token economy system in order to ensure price stability. Nomin, the token issued by Havven, can be used for everyday purposes. The money for the token is returned back to the company, then allocated among token holders.
We should say that this is a relatively new concept; however, the number of offerings to solve the volatility problem continues to amaze.
Basecoin provides a new approach to stable coins. This project is invested via funding from prominent investors. The stable coin called Basecoin coin is linked to an index or asset, the value of which is always under control in order to adjust token supply and ensure the stable value of each asset.
Additionally, Basecoin provides the ability to use two additional currencies: Base Bonds and Base Shares. Both coins offer incentives to customers. Moreover, customers can sell these coins and get economic incentives that also help to maintain asset price stability.
Today, stable coins are considered to be a really experimental and prospective initiative in the cryptocurrency world. The main advantage of stable coins is not just price stability, but also the ability to hold stable value in an asset. Stable coins are perfect, especially in the short-term perspective, as the user can lose money while waiting for a correction. There are always pros and cons in every newcomer. So do your own research on every innovation you are going to use in your investments because your money and nerves are at stake. If you doubt using stable coins, contact Applicature for professional advice.