The cryptocurrency market is notoriously volatile, with prices swinging up and down daily. This volatility makes it hard for people to trade without constantly worrying about the price of their coins. Stablecoins are one way to combat this problem by pegging the coin’s value to something like gold or fiat currency like USD. 

In this article, we will explain how Stablecoins work and how they might benefit your trading strategy.

What are Stablecoins?

Stablecoins are cryptocurrencies with stable prices. More significantly, they combine the benefits of cryptocurrency, such as decentralization and immutability, with the stability of fiat currencies such as dollars or euros.

For example, fiat-backed Stablecoins, like Tether (USDT), hold reserves in a traditional currency such as the dollar and aim to maintain a 1:1 ratio with said currency. The appeal of this type of Stablecoin is that, unlike other cryptocurrencies, it retains its value and can be used to transact without having to change back into fiat first – though trading them on exchanges often results in you selling them for Bitcoin or Ether before that happens.

These coins are desirable because they allow institutions to tokenize fiat currencies in a decentralized, inexpensive, and fast manner.

How do Stablecoins work?

Price volatility is bad news for any merchant that allows Bitcoin or other cryptocurrencies to be used to purchase goods or services; merchants don’t want the price of the products they’re selling to fluctuate in such a volatile market since it makes it challenging to keep their own books balanced. This is where Stablecoins come in: they hold a stable value and are designed specifically for use as a “medium of exchange,” or what you might think of as “money.”

Stablecoins or other cryptocurrencies can allow merchants to set their prices based on the price when the customer comes in and needs to purchase the product (rather than worrying about day-to-day increases or decreases). Customers don’t have to worry that the value of their payment will suddenly plunge before or after their purchase.

Types of Stablecoins

There are currently two types of Stablecoins: Fiat-collateralized and Crypto-collateralized. Each type has variations and different implementations, but we will focus on the two main Stablecoin types.

Fiat-collateralized Stablecoins

These Stablecoins are infamous for having severe price volatility against their pegged currencies such as the USD, EURO, etc., due to lack of liquidity, market fluctuations, and speculation by traders looking to make a profit. These Stablecoins hold reserves in the underlying fiat currency, which is then held using an escrow account that transfers ownership of money from one party to another depending on price fluctuations or demand for redemption of each coin where its 1:1 value is redeemed against the fiat currency.

A majorly known example of this Stablecoin is Tether (USDT). While it has a 1:1 value ratio to the USD, there has been speculation about whether they actually hold reserves to back up their supply of coins. There have also been discussions around how much USDT is backed by actual USD and other crypto-assets. It would not be possible to redeem all coins at once because exchanges may consider this a collapse in market operations, thus being shut down. Other issues with fiat-collateralization are that there are just way too many risks involved, which can lead to bankruptcy or shutdown of the business if anything goes wrong.

Fiat-collateralized Stablecoins, just like any other decentralized cryptocurrency, can be hacked. It is of utmost importance that these escrow accounts are cryptographically secure and the use of multi-signature wallets for transactions to take place between two parties.

Crypto-collateralized Stablecoins

These Stablecoins hold their value through an alternative method that involves cryptocurrencies as collateral instead of fiat money like USD, EURO, etc. These coins carry out their operations on distributed blockchain networks (Ethereum (ERC20), Omni, NXT, etc.) which act as the foundation for running smart contracts for transactions to be made on the network against its pegged currency without any risk of default since this would require 51% attacks against the underlying blockchain network which is impossible with Proof-of-Work or Proof-of-Stake consensus algorithms used by any of these cryptocurrencies.

The only leading player with successful crypto-collateralization was MakerDAO which entered its market testing phase on December 18, 2017. Their Stablecoin, PETh, which carries a 1:1 value ratio pegged to the USD, holds ETH as collateral for generating its supply of coins against ETH held as a reserve.

Other players like Havven and Basecoin are entering their market testing phases sometime this year. Their crypto-collateralized Stablecoins are NVST (1:1 value ratio to USD) and Basecoin (titled Basis), respectively, which will operate on the Ethereum network using the ERC20 token framework.

Benefits of Stablecoins

1. Faster transfers

The transactions are faster because they do not need to go through banks or other financial institutions. Once the sender has sent the money, it is automatically transferred to the receiver’s wallet instantly. The transfer is trustless and sometimes finished within minutes.

2. Low fees

Through peer-to-peer payment networks, no transaction fees are charged by financial institutions like banks or PayPal, which cut down on costs. On some platforms, this may lead to micropayments of fractions of cents for each transaction.

3. Resistance to censorship

No one can prevent users from sending or receiving coins because there is no central authority involved. As long as you have access to the internet, you can instantly send or receive any amount of money.

4. Durability

Stablecoins exist just like bitcoins in an immutable form, forever recorded on a distributed ledger spread across many nodes worldwide, making it indestructible and immune to corruption or hacking.

Should you invest in Stablecoins?

If you’re on the fence about whether to buy stablecoins, consider your investment objectives. Stablecoins can be a smart option if you want to hold crypto as a method of payment that isn’t as volatile. If you want to lend or stake your coins and take a hands-on approach, stablecoins may be for you.

Top 5 stablecoins by market capitalization

With the expanding number of stablecoins, it is important to know which ones are most helpful and well-anchored.

StablecoinMarket Cap
Tether (USDT)$68,560,358,054
USD Coin (USDC) $32,765,483,268
Binanace USD (BUSD)$13,070,754,735
Dai (DAI)$6,476,739,095
Terra USD (UST)$2,735,270,539
(The above details stand valid as of Oct 16, 2021.)

Tether (USDT)

Tether is a cryptocurrency which has the value of one US Dollar. It was created by Tether Limited and can be exchanged with other cryptocurrencies such as Bitcoin or Ethereum. The idea behind this currency is to provide stability against the volatility of Bitcoin and Ethereum price, hence its name “Tether”.

Tether’s primary use case is to hold funds for personal use without any risk from high volatility currencies like bitcoin or ethereum while still being able to transfer them across exchanges without incurring any transaction fees due to their underlying blockchain architecture that supports unlimited transfer of funds at any time.

USD Coin (USDC) 

The USD Coin, based on the Ethereum blockchain technology, was launched at the end of September 2018 by the CENTRE Consortium supported by Circle Internet Financial Ltd. The USDC tokens are pegged to US Dollars 1:1 and are available for purchase on many exchanges including Binance, OKEX, Huobi Global or Poloniex .

Binance USD (BUSD)

Binance is involved in the creation of BUSD which is pegged 1:1 to the US Dollar. It was created on Ethereum but it will be transferred to EOS , which will provide additional scalability and speed for BUSD.

Binanace has launched an OTC trading desk (OTC) with direct purchase of digital currencies with U.S. dollars , which reduces the price at which it is traded in the secondary market, tokens are credited to your account/wallet once they receive payment from clients “in fiat” (USD).

Dai (DAI)

Dai is a stablecoin created by MakerDAO (MKR), it has two tokens, one is denominated in Euro (DAI) and one in US dollar (USDT). The token price is pegged to 1 USD worth of Collateralized Debt Positions (CDPs). Each CDP holds Ethereum as collateral and is protected against volatility risk. The MakerDAO platform allows users to generate new DAI tokens using the ETH as collateral.

Terra USD (UST)

The Terra stablecoin is backed by USD and was launched at the beginning of 2018. It is available for purchase on Huobi Pro, Bitrue or OKEx. It has a daily close price to the US Dollar.

The Bottom Line

Stablecoins are becoming increasingly popular because of the benefits they offer traders. The key reason for this is their stability, which means these tokens can be traded on exchanges with less risk than other cryptocurrencies. This makes them a wise investment choice if you want your money tied up in cryptocurrency without it fluctuating too much.

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