A stablecoin is a cryptocurrency that is backed by another stable asset such as fiat currency (USD, EUR, JPY etc), gold and commodities. This is done to reduce the volatility of the coin by backing it with something that has a stable value.
Stablecoins were created in order to minimize the volatility of cryptocurrencies. It allows people to use a cryptocurrency that is stabilized and pegged to a specific value. Stablecoins retain the benefits of being a decentralized digital currency – low transaction cost, almost instantaneous transaction times, trustless and outside the control of a single entity – while avoiding price volatility.
For countries where inflation can render government-issued currency into meaningless pieces of paper in a short period, stablecoins can provide a welcome respite from uncertainty and hyperinflation.
For traders who want to hedge their investments, they can transfer their crypto holdings to stablecoins if they believe their cryptocurrencies will be dropping in value.
Usually stablecoins have an inverse relation to the crypto markets – when they are down, the trading volume and market cap of stablecoins increases, and when the crypto markets are up, stablecoins decrease.
Fiat-backed stablecoins are those that are backed by a 1-to-1 ratio of the fiat currency to the stablecoin so that the value always stays pegged to the traditional currency. Fiat-backed stablecoins are the most common stablecoins that exist today and are most commonly backed by USD. Examples of well-known, fiat-backed stablecoins are USDT (Tether), USDC (Circle), TrueUSD (TrustToken), PAX (Paxos) and GUSD (Gemini Dollar).
Commodity-backed stablecoins are those that are backed by any commodity that is fungible (i.e. interchangeable) when it’s traded on a market. Examples of these types of commodities would be oil, precious metal or grain. Commodity-backed stablecoins are currently backed by either gold or oil.
Examples of well-known, commodity-backed stablecoins are Stable Gold (GLDS) and oil-backed cryptocurrency in Venezuela’s “national cryptocurrency”, the Petro.
GLDS are backed by real gold kept in a vault and every GLDS is redeemable for 1g of gold. While the global market is slowing down, it might be a good idea to start investing in a gold-backed token as gold ha always been proven to have safe-haven qualities.
Crypto-backed stablecoins are those that are backed by other cryptocurrencies, usually the ones with the largest market caps such as Bitcoin and Ethereum. Crypto-backed stablecoins can be backed by either one cryptocurrency or a mix.
Due to the volatility of cryptocurrencies in general, most crypto-backed stablecoins are backed by a mix of cryptocurrencies to offset the risk of holding just one cryptocurrency as collateral. Crypto-backed stablecoins are usually over-collateralized in order to account for fluctuations in the price of the underlying cryptocurrency. This helps to maintain the stability of the stablecoin at a set price.
Examples of well-known, crypto-backed stablecoins are DAI (Maker DAO), bitUSD (BitShares) and sUSD (Synthetix).
Non-collateralized stablecoins are stablecoins that are not backed by any assets but use algorithms to adjust the supply and demand of the stablecoin in order to keep the value stable.
Examples of non-collateralized stablecoins are CarbonUSD (Carbon) and kUSD (Kowala).
Cryptocurrencies are still in their infancy, and this is even more true with stablecoins. This new form of digital currency is still taking form and have yet reach it maturity.
Each form of stablecoin comes with its pros and cons, and none of them are perfect. Yet the value and stability they could provide to businesses and individuals globally, by enabling universal access to established national currencies could be disruptive.
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