What are Stablecoins and How are They Different from Other Currencies

It shouldn’t be news to you that cryptocurrencies are very volatile.

From Ethereum to Bitcoin, these cryptocurrencies experience constant and uncertain changes in their value. Because everyone has access to buy and sell cryptocurrencies without restriction, the market conditions cause volatility. Just as you can become extremely rich overnight, you can also lose your investment in a few hours. For investors with low-risk tolerance, cryptocurrencies are usually a no-no.

However, there is a subset of cryptocurrencies that do not have the volatile nature of other cryptocurrencies. They are called stablecoins.

What are stablecoins?

A stablecoin is a cryptocurrency whose value is pegged or tied to another currency (for example, the U.S. dollar or Euro) or to the price of a commodity (such as oil, gold, or real estate). For example, BUSD is tied to the U.S. dollar, but PAXG is tied to the value of gold.

Just as the name suggests, they are stable and do not fluctuate sporadically.

Stablecoins bridge the gap between fiat currencies and cryptocurrencies. It offers the security and privacy of cryptocurrencies and the stability of the traditional government-backed currency. These coins are best suited for investors who do not have a high-risk tolerance to stomach the volatility of cryptocurrencies.

How are stablecoins different from other cryptocurrencies?

Unlike other cryptocurrencies, stablecoins are not “mined” by an open network of computers. Instead, their prices are determined by the value of another asset. They track the underlying asset, which makes them stable in relation to the asset they are pegged to.

Other cryptocurrencies are backed by nothing at all.

Stablecoins are also relatively stable, unlike cryptocurrencies which are highly volatile. Like we mentioned earlier, cryptocurrencies fluctuate greatly. Their value increases and decreases sporadically as they are traded for profits.

Stablecoins are used as an alternative to fiat currencies, especially since they are usually pegged against the fiat currency and have similar value.

What are stablecoins used for?

Stablecoins are used to:

a. Carry out routine transactions

Thanks to their high volatility rate, it is risky to carry out routine transactions with cryptocurrencies. For a currency to serve as a medium of exchange, it must remain relatively stable so that it can retain its purchasing power in the short term. Cryptocurrencies cannot guarantee these. However, stablecoins can retain their value.

b. Lend cryptocurrency to customers

Some DeFi (Decentralized Finance) platforms, for example, Celsius, use stablecoins to lend crypto to their customers. They do this because it is very unlikely that the value of the coins dramatically changes between the time the loan is approved and when the cryptocurrency gets to the customer’s wallet.

c. Avoid paying transaction fees on cryptocurrency exchanges

Some crypto traders and investors use stablecoins to avoid paying transaction fees on crypto exchanges like Binance. Many of these exchanges do not charge transaction fees for exchanging stablecoins for U.S. dollars.

What are the different types of stablecoins?

The different types of stablecoins include:

1. Crypto-collateralized stablecoins

Crypto-collateralized stablecoins are stablecoins that are backed by other cryptocurrencies. Instead of a central issuer, this type of stablecoin makes use of smart contracts. An example of crypto-collateralized stablecoins is DAI.

To purchase crypto-collateralized stablecoins, you lock your cryptocurrency into a smart contract to get tokens of equal value. The process is similar when you want to withdraw your collateral. You put your stablecoins back into the smart contract and get your collateral.

Since cryptocurrencies are volatile, these stablecoins are over-collateralized. This means that the value of the cryptocurrencies held in reserve by smart contracts is greater than the value of the stablecoins issued.

For example, to issue $1,000 of a crypto-backed stablecoin, cryptocurrency worth $2,000 can be held as a reserve. This protects the stablecoin against a decline in the value of the cryptocurrency in reserve.

2. Fiat-collateralized stablecoins

Just as the name implies, fiat-collaterized stablecoins are backed by fiat currency.

These stablecoins maintain a reserve of fiat currency such as the U.S. dollar as collateral. Other forms of collateral can include precious metals (such as silver or gold) or commodities like crude oil. The collateral remains in reserve with a financial institution or a central issuer. Also, the collateral has to be commensurate to the number of stablecoin tokens in circulation.

For example, if $1 million of fiat currency is issued, it can only circulate 1 million stablecoins — each coin worth one dollar.

This type of stablecoin is considered an off-chain cryptocurrency because it does not have another cryptocurrency as collateral. Examples of fiat-collateralized stablecoins include USDC and USDT.

3. Algorithmic stablecoins

The major difference between algorithmic stablecoins and others is that the value of the stablecoin is kept stable by controlling its supply through an algorithm — a computer program running a preset formula.

When the market price falls below the value of the fiat currency the algorithm tracks, the algorithm system reduces the number of stablecoins in circulation. In the same vein, if the value of the stablecoins surpasses the value of the fiat currency the algorithm tracks, new tokens are distributed to adjust the value of the stablecoins.

This type of stablecoin may or may not hold assets in reserve. An example of algorithmic stablecoins is Alpaca USD.

What are the top stablecoins to explore?

1. Tether (USDT)
2. Binance USD (BUSD)
3. USD Coin (USDC)
4. True USD (TUSD)
5. Dai (DAI)
6. Pax Dollar (USDP)
7. Digix Gold Token (DGX)

Where can I get stablecoins?

You can buy stablecoins on crypto exchanges like Binance and Coinbase. You can also get stable coins on DeFi platforms like Xend Finance.

Xend Finance is a crypto bank that allows you to convert your fiat currency into stablecoins and earn up to 15% interest when you save on the Xend Finance app. This interest rate is amongst the highest in the industry, while your funds are insured.

You can also stake your stablecoins on their native staking platform and receive high returns.

Take the first step towards owning stablecoins today. Click here to download the Xend Finance app and get your first stablecoin.

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