Stablecoins are a secure and stable type of cryptocurrency that have become an integral part of the blockchain experience for both retail and institutional investors.

Cryptocurrencies are volatile in nature and can be a double-edged sword, making them unsuitable for some investors and businesses wishing to hold crypto-based assets. 

Enter stablecoins, a digital asset class designed to provide stability and security in cryptocurrency and Decentralized Finance.

Over the years, stablecoins have been in the mainstream news for various reasons. Recently, PayPal has released its rendition of a stablecoin, PayPal USD (PYUSD).

We also have seen  BlackRock’s CEO, Larry Fink partnering with  Circle, the company behind USDC, one of the most popular Stablecoins. Though there are cases of negative press for stablecoins such as USDC depegging its value that are important to know of when learning about this type of cryptocurrency.

In this guide, we'll answer the fundamental question, "What are stablecoins?" and give you a clear understanding of why they are such a dominant force in the world of cryptocurrencies.

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What Are Stablecoins?

Stablecoins are a unique type of cryptocurrency that aims to maintain a stable value by pegging their worth to a reserve asset. Unlike Bitcoin or Ethereum, which can experience wild price swings, stablecoins are designed to keep their weight steady.

We will cover different types of stablecoins further in this blog, but to set the scene, one of the most famous examples of a stablecoin is USDT. For this crypto to maintain its value and remain stable, it is pegged against the U.S. dollar.

The brains behind USDT are Tether Limited Inc., which minted their first stablecoin  in 2014. By 2022, USDT was made available via ten different protocols and blockchains, indicating its popularity

Both retail and institutional investors use stablecoins as a middle ground when operating on the blockchain. To save on additional fees when switching crypto and fiat currencies, you hold funds as a stablecoin. Also for off-chain transactions, it is possible to save on fees as stablecoins can be used as payment without needing to be changed back to fiat currencies.

And thanks to the introduction of crypto-based debit and credit cards, it is now easier to use your stablecoins and other everyday tokens, whether to pay for groceries or other essentials. 

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Key Characteristics of Stablecoins

It is essential to understand the critical characteristics of stablecoins. Doing so allows you to use them to their full potential.

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Price stability: They maintain a stable price, usually at a 1:1 ratio, with a reserve asset like the US dollar (USD), gold, or other cryptocurrencies.

Backed by assets: Stablecoins are often supported by a reserve of real-world assets, ensuring their value is tied to something tangible.

Transparency: Reputable stablecoins offer transparency, allowing users to verify the reserves that back the coin.

Liquidity: Stablecoins are highly liquid, making them suitable for trading, purchasing goods and services, and transferring funds quickly.

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Types of Stablecoins

There is a diverse array of stablecoins available, each with its own unique features, mechanisms and utility.

1. Fiat-collateralized stablecoins:

These types of stablecoins are backed by fiat currencies making them one of the most stable types available. More and more fiat currencies  (not just the US dollar) have had a stablecoin created in conjunction with it, showing how useful they are becoming for the whole world.

Examples of fiat-collateralized stablecoins

Euro Coin (EURC): This stablecoin is backed by the Euro used within a number of European countries. It is accessible across Ethereum, Avalanche and Stellar and is brought to us by Circle like many other stablecoins such as USDC. 

Tether (USDT): TetherUSD is one of the most popular fiat-collateralized stablecoins. It's widely used in crypto trading but has faced scrutiny due to concerns about its reserves transparency.

USD Coin (USDC): Circle’s USDC is another widely adopted fiat-collateralized stablecoin, known for its focus on transparency and regulatory compliance.

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2. Crypto-collateralized stablecoins:

Crypto-collateralized stablecoins are a type of stablecoin designed to maintain a stable value by being backed or collateralized by other cryptocurrencies. 

These stablecoins aim to provide the benefits of both cryptocurrencies and stable value, making them suitable for various use cases, such as online purchases and value storage, without the price volatility. 

Examples of crypto-collateralized stablecoins

Dai (DAI): Dai is a decentralized crypto-collateralized stablecoin that maintains its value through Ethereum collateral. It's governed by a decentralized community and has gained popularity in the decentralized finance (DeFi) space.

sUSD (sUSD): sUSD is backed by a basket of cryptocurrencies, providing stability through a diversified collateral pool.

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3. Algorithmic stablecoins:

Algorithmic stablecoins are a type of stablecoin designed to maintain their value through algorithmic mechanisms, without the need for assets like fiat currencies or other cryptocurrencies. 

They use smart contracts and algorithms to automatically adjust their supply in response to changes in demand, aiming to keep their value constant.

Examples of algorithmic stablecoins

Ampleforth (AMPL): Ampleforth is an algorithmic stablecoin that adjusts its supply based on demand, aiming to achieve a stable price over time.

Frax (FRAX): Frax is another algorithmic stablecoin that uses a unique mechanism to maintain stability, combining fractional collateralization with algorithmic adjustments.

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4. Commodity backed stablecoins

Commodity-backed stablecoins are a type of cryptocurrency designed to maintain a stable value by being pegged to a specific commodity or a basket of commodities. 

The value of these stablecoins is tied to the price of the underlying commodity, which can be precious metals, agricultural products, or even energy resources. The most common commodity used as a backing for stablecoins is gold, but other commodities like silver and oil can also serve as the collateral.

Examples of commodity backed stablecoins

Tether Gold (XAUT): Tether Gold is a stablecoin issued by Tether, one of the most well-known stablecoin issuers. It is backed by physical gold stored in Swiss vaults. Each XAUT token is equivalent to one troy ounce of gold, providing a stable store of value.

PAX Gold (PAXG): Paxos Standard (PAX) is a stablecoin, and PAX Gold is a specific version of it backed by physical gold. Each PAXG token is backed by one fine troy ounce of a 400 oz London Good Delivery gold bar.

Energy Token Commodity (ENC): Energy Token Commodity is a stablecoin backed by energy resources. It is designed to provide stability by tying its value to a basket of energy commodities, making it unique among commodity-backed stablecoins.

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Investors are spoilt for choice when picking out a type of stablecoin. Each has an array to choose from depending on who, why, and how you will use them on the blockchain.

Be sure to always research a stablecoin before choosing one. You can do so by visiting CoinMarketCap, where a complete, comprehensive breakdown of the token is given, along with market statistics to provide a clear picture.

Positives of Stablecoins

- Hedging against volatility: Stablecoins provide a haven for crypto investors during periods of extreme volatility.

This is important for many reasons. You may want to stake your crypto but are worried about the value of your returns being affected by market conditions. 

The choice to put your money into a stablecoin offers users more selection in personal finance and business.

- Facilitating transactions: Stablecoins enable quick and low-cost transactions, making them suitable for daily use.

Blockchains like Ethereum are not the most accessible networks for day-to-day transactions. Hefty gas fees hold it back, which can add up if you process numerous payments over time. Therefore, stablecoins are a vital option.

- Smart contract integration: Stablecoins can be integrated into smart contracts on blockchain platforms like Ethereum, enabling programmable financial transactions, decentralized finance (DeFi) applications, and more.

Intelligent contracts are pivotal in DeFi applications, which often involve stablecoins. DeFi platforms use smart contracts to automate various financial services, such as lending, borrowing, trading, and yield farming. Stablecoins are used as a stable unit of account in these platforms, and intelligent contracts control the terms and conditions of these financial transactions.

Negatives of Stablecoins

- Centralized risk: Fiat-collateralized stablecoins rely on centralized entities to hold reserves, which can be susceptible to regulatory pressure.

Furthermore, this goes against the ethos of crypto and blockchain technology. For example, centralized entities may have a say in how a stablecoin can be used and distributed. 

- Lack of transparency: Some stablecoins may not provide sufficient transparency regarding their reserves. To learn more about a specific example of the lack of transparency with stablecoins, read further down our blog. 

- Counterparty risk: Users of stablecoins are exposed to the risk that the issuer may be unable to honor the 1:1 peg. Different stablecoin providers will use various financial service providers to ensure their tokens can be backed against a reliable asset. 

For example Tether uses: 

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• Agricultural Bank of China Ltd
• Bank of China Hong Kong
• Bank of Communications Co Ltd
• Industrial and Commercial Bank of China
• China Merchants Bank
• China Construction Bank
• China Everbright Bank Co.

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They ensure assets are backed through commercial paper.

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Use Cases of Stablecoins

Stablecoins have found different use cases for blockchain developers, investors and traders, making them a go-to for anyone actively using the technology and services. 

1. Trading and Investment:

Traders often use stablecoins to hedge against market volatility and secure profits during price swings.

Stablecoins are a stable base currency for crypto-to-crypto trading pairs on various exchanges.

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2. Remittances and cross-border payments:

Stablecoins offer a faster and cheaper alternative to traditional cross-border payment methods. Workers sending remittances to their home countries can benefit from reduced fees and quicker transactions. 

Businesses use the blockchain to facilitate payments both inland and abroad. This makes stablecoins a great option as they have stability in value and require very little knowledge of blockchain, unlike other cryptocurrencies.

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3. Decentralized finance (DeFi):

Stablecoins play a pivotal role in DeFi protocols, providing collateral, liquidity, and stable value to various applications like lending, borrowing, and yield farming.

For example, when you visit our exchange, you will notice that we operate our coin listings in conjunction with USDT. This is a trading pair; an example is BTC/USDT. 

You can also stake your stablecoins on DeFi platforms. Staking is a great way to earn passive income on the blockchain, and doing so with a stablecoin adds an extra layer of safety due to it not being volatile in price. 

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4. Everyday transactions:

Stablecoins can be used for everyday purchases, much like traditional currencies.

They are becoming increasingly accepted by merchants and businesses, offering an easy transition from fiat to digital currency. Some examples of businesses accepting stablecoins as 

payment include Travala, Amazon (for gift cards) and Alternative Airlines.

Crypto credit and debit cards are becoming popular, with Mastercard and Visa teaming up with different providers to offer a seamless blockchain experience in the real world.

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Impact on the Crypto Space

Crypto and blockchain industries are ever expanding and the introduction of new concepts are always welcomed with open arms. Widespread adoption of stablecoins has had a significant impact on the crypto ecosystem. 

Positives:

- Reduced volatility: Stablecoins provide stability and mitigate the fear of extreme price fluctuations, attracting a wider audience of investors and users.

This is an important feature, as many are skeptical about cryptocurrencies and their price volatility making them less likely to invest and engage in them. 

- Increased liquidity: The availability of stablecoins has improved liquidity in the cryptocurrency market, making it easier for traders to enter and exit positions.

It was recorded in May 2022 that stablecoins amounted for 45% of the liquidity in decentralised exchanges showing the dominance that they have. 

- Facilitating growth of DeFi: Stablecoins are the lifeblood of DeFi platforms, enabling various decentralized applications to thrive and providing users with a stable medium of exchange and collateral.

As time progresses more decentralized apps are made on blockchains like Ethereum and Solana. This creates a reliance on onboarding users, which is possible thanks to stablecoins being easily swapped to tokens such as ETH and SOL. 

From there they can be used on decentralized exchanges to be swapped into more niche tokens that may not be available on centralized exchanges. 

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Negatives

- Regulatory scrutiny: Stablecoins have faced increased regulatory scrutiny, particularly those backed by fiat currencies. Regulators are concerned about their impact on the financial system and potential risks.

While the crypto industry is still growing, there is still little regulation around stablecoins. As a result, unauthorized bodies can issue stablecoins, using them as liquidity to back their crypto tokens and services on the blockchain. 

- Centralization concerns: Fiat-collateralized stablecoins are centralized to some extent, which goes against the decentralized ethos of cryptocurrencies.

With fiat currencies being printed by banks, which are centralized, this basically means banks have a hand in the enabling of stablecoins which many may see as a threat to the democracy crypto brings forward. 

- Competing interests: The dominance of certain stablecoins, like Tether, has raised concerns about their influence on the broader crypto market.

Tether’s founder has had to come out and back up claims that their stablecoin has a hand in market manipulation stating, “Tether has never engaged in any sort of market or price manipulation. Tether issuances cannot be used to prop up the price of Bitcoin”

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The Tragic Story of Terra Luna

If you have watched crypto markets over the last few years, you will undoubtedly hear of Terra Luna. The Singapore-based Terraform Labs set up this cryptocurrency, and they had a stablecoin called TerraUSD (UST). 

TerraUSD had a sister coin, Luna, which subsequently crashed in price during the 2022 bear market. The value of the stablecoin began to depeg and a lot of speculation began surfacing around the founder, Do Kwon.

Luna was one of the most significant coins then, with many investors flocking to it as the price surged to an all-time high of $119.18 in April 2022 before dropping a month later in May. 

The crypto incentive at the time was not there, and there was a mass sell-off of TerraUSD stablecoin. Luna went down in value significantly as billions got wiped in market capitalization. As a result, Luna's fate was sealed as the price tanked by 99.99% by the end of May because it was pegged against TerraUSD.

Cryptocurrency prices felt the full effect of the Luna crash. By the end of it, coins like Bitcoin and Ethereum were directly impacted, and a total of $300 billion was wiped.

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Stablecoins and the Future of Crypto

In a world where the price of cryptocurrencies can change dramatically in minutes, stablecoins offer a reliable anchor. As we've explored, stablecoins are a powerful category of digital assets with various use cases. 

Whether you're a crypto investor looking to hedge against volatility or someone interested in the broader cryptocurrency space, understanding stablecoins is a crucial step toward navigating this exciting financial frontier.

Remember, while stablecoins provide stability, they also come with their own risks and challenges, so it's essential to do your due diligence before diving in.

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Frequently asked questions

• What is the purpose of a stablecoin?

The primary purpose of a stablecoin is to offer price stability in the volatile world of cryptocurrencies. They aim to maintain a relatively steady value, often pegged to a traditional currency, making them suitable for everyday transactions and as a store of value.

• Are stablecoins a good investment?

Stablecoins are generally not considered long-term investment assets. While they offer stability, they typically don't provide the same growth potential as more volatile cryptocurrencies. However, they can be a safe haven during market downturns and are useful for traders seeking to reduce exposure to price fluctuations.

• Are stablecoins getting riskier?

Stablecoins are relatively low-risk compared to other cryptocurrencies due to their stable value. However, they do face regulatory and custodial risks. It's essential to stay updated on regulations and choose reputable issuers to mitigate potential risks associated with stablecoins. It is also important to go for a trusted stablecoin as there have been examples such as TerraUSD that have lost their value despite being backed by the dollar.

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