What Are Stable Coins? [Simple]
Stable coins were created in response to those who fear the high volatility of cryptocurrency exchanges.
They are a digital currency that is consistently valued at $1.
The Purpose of Stable Coins
Have you ever played a phone game that tries to offer you large bundles of coins for “micro-transactions” of your authentic dollars?
You convert your physical cash savings into these “digital tokens” that you can use to buy items within a given game. Within that game and that game only.
You spend those “fake” game tokens on “fake” in-game loot.
Now apply this logic to the real world and eliminate the constraints. Digital tokens that you can spend anywhere and that are worth just as much as your physical cash.
That’s what a Stable Coin is.
You no longer have to carry around physical cash; you don’t even need to keep your money in a bank.
Using a trusted stable coin company, you can convert your $100 physical dollars into $100 digital dollars that you can spend anywhere. Creating a world in which digital asset exchanges directly compete with traditional banks for custody of personal savings.
So, what are the incentives to abandon the traditional banking system?
Why does it matter? The question that exchanges like Coinbase and Crypto.com are most likely reeling over.
It’s a competitive mad-dash to offer the best incentives and convince users to switch to a new saving system. Each exchange is fighting for a piece of the market share in this regard.
Banks are often criticized for their abundance of transactions fees, monthly fees, and overdrafts. Crypto exchanges can efficiently market themselves as a better alternative by simply not forcing users to pay such fees.
Another way exchanges offer incentives is to remove the bank as a middleman. This is very appealing to those who need to move in and out of the markets quickly. Many people call them “daytraders.”
In a world devoid of crypto innovation, investors predicting a price crash had to navigate potential volatility by transferring their riskier holdings into U.S. dollars for protection/stability.
Banks would charge these investors hefty fees to do so quickly.
Now, investors can convert their volatile assets into non-volatile assets stored on the same platform they trade on. Often for no fees and higher interest rates.
An example would be taking your holdings of Dogecoin on a crypto exchange like Coinbase (highly volatile) and transferring it into the stable coin USDC (owned by Coinbase).
Doing so essentially keeps your money safe while the market fluctuates, and you didn’t have to pay the bank hefty transaction fees to do so.
With this strategy, a user can try to time the markets to invest in “buy low” periods and jump out quickly at “sell high” periods.
Examples include Dogecoin, AMC, and Gamestop.
Banks have traditionally skimmed lots of fees off the top of this quick trading process. This previously incentivized users not to quickly jump in and out of investments.
Through the invention of stable coins, this is no longer the case.
How do Stable Coins work?
The base idea is that if you create a digital currency backed by an equal amount of physical cash like the U.S. dollar, it will prevent price swings.
This idea of a backed digital currency is also known as a reserve of value.
These reserves are often built and maintained by companies that create and distribute their own stable coins.
In other words, United States Dollar Coins, created by Coinbase, are also backed by Coinbase.
Privately funded reserves like this make a world in which private corporations can effectively back and distribute their own digital alternatives to physical cash.
In simple terms, private companies can now create an infinite amount of spendable currencies backed by the promise of inherent value.
Sound familiar? That’s because this process is much like the promise of a government currency (dollars) being inherently valuable.
Physical cash is said to be backed by gold. Meaning that both stable coins and physical money are supported on a trust system that each token/dollar has an inherent store of value.
Both of these forms of currencies are viable as a medium of exchange, presenting a difficult decision for people deciding where to store their savings.
The question remains, who do you trust more? The government or company values.
Stable coin reserve types:
- Traditional Currencies: This reserve is the most common collateral for stable coins. The U.S. dollar is the most popular among fiat currencies. Still, companies are exploring stable coins pegged to other fiat currencies as well.
- Precious Metals: Some cryptocurrencies are tied to the value of precious metals such as gold or silver.
- Cryptocurrencies: Some stable coins even use other cryptocurrencies, such as “ether,” the native token of the Ethereum Network, as collateral.
Reminder: a stable coin is a store of value, not a volatile exchange asset.
Who makes Stable Coins?:
Stable Coins are created, marketed, and backed by private entities which claim to possess a large enough store of value to keep the coin’s price valued at an unwavering $1.
As of now, only a few prominent companies have created stable coins. In theory, anyone could with a sturdy enough store of value and a wifi connection.
Current Major Developers (2021):
- Coinbase/Circle — USDC
- Gemini — Gemini Dollar
- MakerDAO algorithm — Dai
Once your money is in Stable Coins, you have three options:
- Trade and spend your stable coins just like you would traditional currencies.
- Lend (aka Staking) your coins to gain higher interest and receive a passive income on your loaned coins.
- Hold the coins in your stable coin wallet while the Crypto market price falls or rises before deciding to buy back in at a better average buy price.
The difference between Stable Coins and CBDC’s
CBDC’s, an abbreviation for Central Bank Digital Currencies, is a stable coin created by governments and central banks.
They are pretty much the same as Stable Coins; their difference largely comes down to the argument between “centralization and decentralization.”
Pomp taught in his Crypto Course that “CBDC’s drastically increase the surveillance capabilities of central banks and governments.”
In layman’s terms, CBDC’s are tracked by governments and central banks. Stable coins are not tracked by the institutions that create them.
In Summary
Exchanging crypto assets for stable coins is far cheaper than exchanging crypto-assets for traditional currencies (USD)
Stable Coins are a cleaner and more efficient digital alternative to fiat currency (physical dollars).
