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What are stablecoins?

Stablecoins offer a simpler approach to handling your fiat currencies on blockchains. Take a look at how stablecoins work.

Source: ethereum.org

Although stablecoins are often pegged to fiat currency, this is not always the case. There are so many different examples of stablecoins and many of them are often overlooked as an investment strategy. Although I won’t dive into suggestions on how to use your money on them, I will take a look at a few different opportunities that exist within the stable ecosystem. There are three primary types of stablecoins that we’ll look at in this post.

How do stablecoins maintain their prices?

Stablecoins were created as a response to the price volatility of cryptocurrency. Although it’s a little different depending on the stablecoin you’re looking at, they typically maintain their price by being backed by collateral. A small-scale example would be if an issuer holds $5000, they can distribute up to 5000 coins that are pegged to the appropriate fiat currency, USD in this case.

Fiat Pegged Stablecoins

These are the most commonly used stablecoins. Fiat coins are tied directly to the currency by a 1:1 reserve held by the coin issuers. At their most simplistic, users deposit actual dollars into a bank account and the account holder issues the equivalent coins. This feels a little contradictory to cryptocurrency since it creates a central entity that holds these funds, but so far it has worked pretty well. However, there are also security risks to these centrally held reserves; they could be hacked, or in some cases the validity of their reserves could come into question. Tether has recently had such allegations against them, a summary of which can be found here, although a recent report is trying to quell them.

A top use for these is as a trading pair for crypto that is not available to be traded directly for fiat currencies, or use on decentralized exchanges as a swapping pair. Even if you’re not going for unknown tokens, these still offer an easier way to trade without constantly depositing and withdrawing from your bank account. Because of this it is pretty common for exchanges to create their stablecoins; Coinbase has the USDC, Gemini has the Gemini Dollar (GUSD), Binance has Binance USD, and so on. There isn’t a lot of variance between how they all function, but they do serve to make crypto trading easier. Exchanges will often offer interest on holding stablecoins, Coinbase for example offers interest on holding either DAI or USDC.

Cryptocurrency-backed Stablecoins

Although I said fiat coins are usually backed by a reserve of the currency, there is an exception. Dai is a USD pegged stablecoin that exists entirely on-chain backed primarily by Ethereum. It uses an overcollateralized loan and repayment method facilitated by smart contracts. The on-chain nature of Dai solves a few of the centralization concerns of other stablecoins. My biggest gripe with it is that it currently is a little tougher to get into due to the nature of Ethereum fees. This is the largest example of a cryptocurrency backed stablecoin.

Others do exist, however. To utilize Bitcoin on the Ethereum chain there is a wrapped Bitcoin token pegged directly to the value of BTC. In the most basic sense, any wrapped token is a crypto-backed stablecoin although they are far from stable due to volatility. Wrapped tokens offer more versatility on DeFi exchanges in particular and this is most often where you will find them.

Commodity Pegged Stablecoins

These coins are backed by a commodity reserve. It follows the same concept as fiat pegged coins, so I won’t dive too much deeper into it. There are a few different commodity coins available on the market. Tether Gold and PAX coin are both backed by gold and ownership of a token can be tied to one troy ounce of gold. Tokens can also be redeemed for bars providing the holder owns about 400 ounces.

Certified Diamond is a company providing different tokens all tied to diamonds in a different way. CDC coin is back by an unallocated 0.05 carat diamond equivalent, this cannot be redeemed and is intended to be a method of exchange. DPASS tokens use the ERC-721 standard and represent an individual diamond. They also offer a DPT utility token that allows for additional services on their platform. Even though they are pegged to diamonds, there is no way to redeem them.

There are a few other commodity coins; Petrodollars ties to oil and natural gas, LODE ties to silver bullion, Power ledger ties to renewable energy, and many more.

Conclusion

So as we can see there are a few different options for how to utilize stablecoins. From trading to using them as a store of value, they offer more simplicity when trading cryptocurrency. The ability to achieve some earnings through staking is also a nice benefit of holding some. As it stands, Tether has the highest 24 hour trading volume. I think as cryptocurrency adoption continues to increase so will the usage of Tether and other stablecoins. I’m especially excited to see Dai continue to gain mass adoption since it offers an entirely on-chain option and more decentralization than others.

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Coinmonks (http://coinmonks.io/) is a non-profit Crypto Educational Publication. Follow us on Twitter @coinmonks and Our other project —  https://coincodecap.com, Email  — gaurav@coincodecap.com

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Alexandra Martinez

Focused on various forms of technology from gaming to cryptocurrency.