Role of Stablecoins in Crypto Market
Why have stablecoins met this much success in recent years despite the abundance of exciting digital tokens on the market?
Being able to successfully pick your way through the highs and lows of investing in cryptocurrency could be quite the thrill. It is possible to become an overnight millionaire as a crypto trader, and to lose it all in a few weeks, or to even make it back in the same amount of time.
The crypto market holds a certain sway, a promise of excitement and hopeful bulls that stablecoins do not at all offer; yet, stablecoins occupy a good percentage of the global crypto total market capitalization.
They are significantly unique in their deviation from the strong inclination for volatility that is often common with cryptocurrencies. But their deviation does not equal a lack of patronization. They are increasingly traded in high volumes throughout the year.
What is Stablecoin?
A stablecoin, just like the name implies, is simply a digital coin that is stable. A coin whose price does not fluctuate. It is a type of cryptocurrency whose value is pegged at a decided ratio to a real-world asset with an almost entirely definite value.
The most popular type of stablecoins – fiat stablecoins – are often pegged to a prominent fiat currency such as the US Dollar in a 1:1 ratio. Thus, if 1000 stablecoins are backed by $1000 in a reserve, their value only ideally fluctuates when the price of the US dollar rises or falls. Other types of stablecoins which are “on-chain” and are not backed by physical coins are often maintained by smart contracts and more complex algorithms.
The first ever serious stablecoin was proposed in 2014 by mathematician Robert Sams as a solution to the high volatility of BTC, ETH, and other cryptocurrencies which were gradually gaining popularity and much-needed credibility. Sams detailed in his paper a mechanism for creating a new coin, which would involve tying the coin to a benchmark asset, and keeping track of the price on an exchange.
Sam’s paper, titled “A Note On Cryptocurrency Stabilization; Seigniorage Shares”, has since gone on to define subsequent algorithms and processes that currently make the stablecoin niche in the crypto space what it is now.
Why Are Stablecoins Important?
To understand the growing importance of stablecoins, one only has to look at their massive daily trading volumes and total market cap.
2021 saw a significant surge in the total market cap of stablecoins on the crypto market, which is important given stablecoins cannot increase significantly in prices or even increase at all, especially for ones tied to fiat currencies like the US Dollar. Therefore, an increase in total market cap can only mean a rise in the number of available stablecoins in the market.
In January, 2021, the total amount of stablecoins in circulation was estimated to be worth about 30 billion USD. Fast forward 8 months, and the total market tripled in value, exceeding 100 billion dollars. There are even more suggestions that this figure will only continue to grow as worldwide interest in stablecoins rises. Why are there more stablecoins in recent times, and why are they becoming more important?
Stablecoins are Predictable
Unlike typical cryptocurrencies, stablecoins are very much predictable. They are not volatile, or erratic, or going to plummet one bad morning after a distasteful tweet or a reckless comment on a talk show.
All-time chart of Tether USD with little to no fluctuations. Source: Coinmarketcap
The predictability of stablecoins make them important assets in investment strategies, giving them a less conventional role, such as they are often used as “stop-gaps”. Stablecoins help investors manage the unending volatility of the crypto market while also providing the time and ease for traders to access new asset classes.
Efficient Payment Methods
This could be the greatest advantage that stablecoins hold over other cryptocurrencies – they are great payment mediums.
How do we know this?
In 2010, a cheeky programmer bought what would become a popular pizza for 10 thousand BTC (which was about thirty dollars at that time). Eight years later, the value of that order had risen to more than $ 29 million due to the extraordinary rise in the price of Bitcoin.
Crypto prices are likely to rise one moment, or to plunge the next, making them less preferred methods of payments.
Rise and Fall. BTC/USD price chart from 2017 to 2020. Source: Coinmarketcap
Because of the inconsistencies plaguing most coins on the crypto market, some companies do not consider cryptocurrencies to be a reliable means of payment.
In 2014, Microsoft was the first to start accepting payments in Bitcoins. But already in 2018, their reception was temporarily suspended due to price volatility. Popular gaming platform, Steam, despite being a big crypto proponent, ultimately made the same decision as Microsoft. With stablecoins, there is no need to be worried about a possible bear.
Although as of 2021, a number of companies from Overstock to Shopify are starting to accept Bitcoins and other cryptocurrencies, crypto payments are still far from being widespread.
Excellent Saving Option
Stablecoins have the virtues of cryptocurrencies (transparency, reliability, immutability, digital wallets, fast transactions, low fees, and privacy). They also have stable and trustworthy traits, as seen in traditional fiats like the US dollar or Euro.
Initially, cryptocurrency holders used stablecoins to save money in the event of a market crash. If Bitcoin became cheaper, they could be converted in just a few minutes to avoid more losses. Without stablecoins, Bitcoins would have to be converted into traditional currencies. Such transactions are not possible on every platform, and a significant commission is charged for them.
International Transfers
In addition, stablecoins are useful in cases where you need to make fast and secure international payments: both for a migrant worker who transfers money to a family, and for a large business that needs a cheap and efficient way to settle with foreign suppliers.
A decentralized, reliable and stable system will have many uses, from cross-border lending to financial planning.
Loan Programs
Furthermore, stability opens the door for blockchain-based loans, prediction markets, and other long-term smart contracts.
Lending programs with stablecoins are high-yield and often in double digits. Stablecoin lending interests can be as high as 20 percent, which is a very good return compared to annual returns on bank saving accounts.
Remittance Service
They are a valid alternative to traditional remittance service providers, their stability coupled with the lower fees provided by blockchain technology makes them a great choice for cross-border transfers and remittance payments. The stability also makes them a safe option in place of fiat money in countries facing hyperinflation and economic instability.
Types of Stablecoins
Though most stablecoins are relatively similar based on their core property which is stability regardless of the volatility of the backing asset, they vary in design. The main divisions are Backed Stablecoins and Algorithmic Stablecoins.
Backed stablecoins are also called collateralized stablecoins. Stablecoins which are collateralized can either be backed with fiat assets, or with commodity assets, or even crypto.
Fiat-collateralized Stablecoins
These are tokens that are pegged at a one-to-one ratio to a government-issued fiat currency such as the US dollar. Fiat-backed currencies are the most popular type of stablecoin. They require a central entity that performs as an independent custodian. The institution directs the process and guarantees that the proper equivalent of the fiat currency is held as collateral for each that is issued.
In a typical transaction with a stablecoin pegged to, say, a dollar, one token equals one dollar and the ratio hardly ever changes by more than tenths of a percent. An advantage of this type of stablecoin is the ease of understanding it allows, however, a disadvantage is present in its lack of transparency. An exchange operator is necessary to carry out transactions and there is no way to know if the protocol is being followed.
Another drawback of fiat-backed stablecoins is the fact that they restrict the actual potential of cryptocurrencies since they are simple digital alternatives to fiat money. Some common examples of fiat-backed stablecoins are Tether (USDT) and USD Coin (USDC).
Crypto-Collateralized Stablecoins
These are stablecoins backed by other cryptocurrencies such as BTC or Ethereum. These types of stablecoins are a lot more transparent because everything is carried out on the blockchain of the backing digital currency. Though these have the advantage of supporting true decentralization, a risk is still present because the underlying currency is still prone to fluctuation.
To make up for the volatility, crypto-backed stablecoins are pegged in unbalanced ratios. This is termed over-collateralization, because a large amount of the backing cryptocurrencies are issued out for a few tokens. A popular example of a crypto-collateralized stablecoin is MakerDAO’s Dai which is backed by Ethereum.
Commodity-Collateralized Stablecoins
These are similar to fiat-backed stablecoins, only instead of being backed by fiat currencies, they are backed by physical and naturally occuring assets.
Stable assets such as real estate, oil, or valuable metals and most popularly gold, are common commodities used as collateral. Holding a commodity-backed stablecoin allows an individual to diversify their asset base; and commodities that would have had to be obtained in large amounts can be owned in fractions. An added benefit of this type of stablecoin is how the values increase alongside the commodities.
As regards the second major category, even though Robert Sams’ Seigniorage Shares were never released, his remarkable proposal served as a fundamental building block for this category of stablecoins. Examples of commodity-backed stablecoins are Paxos Gold, Tether Gold and SilverTokens(SLVT).
Algorithmic Stablecoins
Algorithmic stable tokens, which are also known as non-collateralized stablecoins, are a significant product of Robert Sam’s research.
Algorithmic stablecoins are tokens whose values are not pegged to fiat currencies, digital currencies, or commodities. Their mode of operation is quite similar to the way central banks maintain the stability of fiat currencies but in a decentralized manner following an algorithmic mechanism Mr. Sams described in his paper.
A simple example of the workings of this algorithm is this: if a currency was pegged to the Euro, 1 coin would equal 1 Euro. If the price of the coin surpassed 1 Euro, it would indicate excess demand for the coin. The algorithm would then meet this demand by increasing the market’s coin supply until the price ratio was balanced once more.
If the price were to fall below 1 Euro, however, it would mean there are too many circulating coins, thus the demand falls below the supply. The algorithm restores the balance by contracting the number of coins in circulation. TerraUSD (UST), Fei and Ampleforth (AMPL) are good examples of algorithmic stablecoins.
Popular Examples of Stablecoins
Here is a list of some of the most popular stablecoins on the crypto market.
This is the largest stablecoin there is, making up almost 55% of the market cap of all stablecoins. Founded in 2014, the coin was issued by Tether Limited, a subsidiary of Bitfinex. Tether is pegged to the US dollar and is considered to be one of the most important stablecoins in the industry.
This is another fiat-backed stablecoin that has more than 1.5 billion tokens in circulation. Introduced in 2018, TrueUSD has become increasingly important over the past few years, and is the 75th biggest crypto token by marketcap at time of writing. It is the first regulated currency backed by the US dollar and is an ERC-20 stablecoin.
This is a stablecoin backed by a BTC broker and exchange Coinbase. It is pegged to real-world assets, and though it began on Ethereum, it now operates on the Solana and Algorand blockchains, offering speed and reliability.
PAX is a great choice to invest in and make good profits. It is programmable and can be transferred worldwide instantaneously. It is issued by the Paxos trust company and thus is a safe, regulated choice to store your funds. It is currently priced at $1.
Released by Binance crypto exchange, BUSD is a quick way to fund your transactions and can be used as an exchange medium. Approved by the New York State Department of Financial Services, it offers high customer protection and does not cost anything to create or redeem.
Backed with gold reserves, Pax Gold is the biggest commodity-backed crypto token with a market cap of more than 308 million USD as of time of writing.
Stablecoin Rise vs. Memecoins
A relatively popular type of cryptocurrency, memecoins might be the complete opposite of the notably serious stablecoins in nearly every aspect except their existence as a digital currency. Another Musk-influenced asset, these super cheap tokens also referred to as shitcoins were created as a parody of the Bitcoin alternatives (known as altcoins) popping up all over the crypto industry after 2008.
Just like stablecoins, memecoins have made massive contributions to mainstream adoption. Though they are generally viewed as an unwise option for a long-term investment, memecoins are similar to stablecoins in their reputation as a relatively less risky entry into the crypto space. Their incredibly low costs make them a great choice to get a feel of crypto trading as there is very little at stake.
However, unlike stablecoins which were carefully developed to come across as a sensible, reliable form of cryptocurrency, the founders of the first memecoin called Dogecoin did all they could to make their product a ridiculous choice of currency. Memecoins lack the utility possessed by stablecoins and normally aren’t perceived as anything more than a way to make a little money quickly.
A little more susceptible to the effects of speculation than most coins, memecoins have managed to be quite successful largely due to the support of various celebrities, who just adore their beloved meme-based tokens.
Another significant influence on memecoins is the hugely involved communities these assets quickly gather. The members of these communities are hardly if ever hesitant to promote their coins and tokens on various social media platforms, clamoring for adoption by major firms and organizations.
Though their methods have rarely failed them so far, this sort of sway is just the thing stablecoins are expected to negate. Despite the rapid growth memecoins have experienced this year, it is highly unlikely that their whimsical nature can allow them to provide the sustainability promised by stablecoins.
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