In the world of financial options for the protection of value, cryptocurrencies such as bitcoin often encounter one key disadvantage for its broad adoption for daily payments: price volatility. One solution that stands out for this current problem are stablecoins, which are tokens pegged to a stable form of value.
In short, stablecoins are tokens (usually ERC-20 tokens) that keep their price stable by linking it to a strong form of value, from fiat currency like dollar or euro to goods like gold or immovable assets.
This new type of cryptocurrencies represent an attractive alternative for today’s money, as it takes both the anti-inflationary system of cryptocurrencies, along with a value backup similar to the early fiat money.
How Do They Work?
Going back to basic economics, pegging is a form of currency stabilization. As for today, over 66 countries, including Argentina, Hong Kong and Panama, have pegged their local currency to the US dollar. This is due to the fact that the dollar works as the world’s reserve currency, with most international trade done with it.
The peg on a real-world value is the main differentiator of stablecoins with other cryptocurrencies. This peg works by a fixed exchange rate, where each token is valued on a certain amount of the value it’s pegged to. This is the way stablecoins such as Tether work. An example of how this fixed rate would be:
1 token = 1 USD
Also unlike other cryptocurrencies, stablecoin’s main benefit is centered in their use for daily payments and save investment. For this, they are usually pegged to the US dollar, but this is not their only backup, with various types of stabilization strategies for each token.
Among their technical possibilities, being ERC20 tokens, stablecoins can be easily integrated into DApps or related apps. Thanks to this feature, most of the DeFi (decentralized finance) movement is built on top of stablecoins.
Type Of Stablecoins
There are two major groups of stablecoins, each one working with a different pegging form: asset-collateralized and non-collateralized.
- Asset-Collateralized: This stablecoin is usually backed by a value that’s issued by a central authority. This means it's backed up by an external value, which moves outside of the token’s blockchain. This value can either be another cryptocurrency, a fiat currency or even goods, such as gold or properties.
Inside this category we can name three sub-types:
- Collateralized by fiat currency: These stablecoins work by being traded directly in the company’s platform in exchange for the fiat currency, usually the US dollar. In this case, the company appeals to the trust of its clients, claiming to have a reserve of enough dollars to backup every token. The main idea is to assure users that they will be able to return their tokens in exchange for dollars without losing the value of their investment.
- Collateralized by cryptocurrencies: This a decentralized type of token, which uses other cryptocurrencies to maintain their own value stable, each working with their own strategy. As an example of this type of token, in Atix we’ve had experience in the development of such systems, with Money On Chain -a stablecoin backed by bitcoin's price- as our latest project. Other examples of these tokens are the ones issued by MakerDAO: DAI and SAI, which work both with a multi-collateralized (multiple backups within different tokens) and single-collateralized strategy. These tokens are both backed by Ethereum’s cryptocurrency, ether.
- Collateralized by goods: This type of stablecoins use goods, such as gold or even properties to stabilize their price.
- Non-Collateralized: This type of stablecoins are not backed up by any external source of value. Instead, they use algorithms of buying and selling to avoid variations in their price. We can count among the features of these tokens: the autonomy from external markets, decentralization and stability by adjusting value according to the market.
The use of stablecoins is starting to resonate as a safe store of value, especially among countries facing inflation or distrust of their financial central authorities. Central banks have also joined to the general interest toward the use of these tokens, giving the benefits these tools offer in terms of efficiency, transparency and speed in financial services.
The projection for the development of these tools is set to be quite popular in the near future, as it has started to draw attention from major financial players for their use for payments and store of value.
Here in Atix we want to keep on creating new solutions, including Dapp services. If you have an idea and want us to help us keep building, please drop us an email to info@atixlabs.com
