Stablecoins: Things you need to know

Stablecoins: Things you need to know
Overview of stablecoins and their role in the market Cryptocurrencies

What are stablecoins?

Stablecoins are a special type of digital asset that represent the value of another currency or asset found outside of this asset’s blockchain. Investors may think of it almost as a derivative product, in that there is an underlying asset involved. “Stable” references that the outside asset is more constant relative to the value held on this asset’s current blockchain. Major cryptocurrencies, Bitcoin and Ether, are renowned for their volatility — which have been the boon and bane of many investors. The most popular currency that stablecoins represent is the US Dollar, thereby allowing for stable on-and-off ramps for investors, a process that previously involved multiple costly transfers between fiat and cryptocurrencies.

Why use cryptocurrencies?

Cryptocurrencies have several potential advantages over using regular fiat. Fiat requires trust in the central issuing government body. Since all major currencies have decoupled from the gold standard in the latter half of the last century, fiat is no longer backed by a hard asset, meaning that value in a fiat currency is tied to trust in the issuing body. The US Dollar and Euro have a high amount of trust and support, but that’s not the case with other currencies. Zimbabwe’s dollar was effectively abandoned as a national currency in 2009 due to hyperinflation. Cryptocurrencies offer a higher level of transparency since all transactions are stored on an immutable ledger. This detailed record-keeping reduces the need for paid intermediaries to verify if and when transactions occurred. Also, consumers benefit from lower transaction fees with remittances. Cross border transactions no longer have to do multiple hops between intermediary currencies based on what individual banks support. Value can be moved in a single step from one user to another. Certain cryptocurrencies allow for programmable logic to be built into blockchains as well.

Cryptocurrencies aren’t sufficient?

Investors have entered the digital asset ecosystem for a number of reasons. Ethereum¹, with the use of smart contracts², offers a multifunctional protocol that has seen significant application development and financial proofs of concept. Ethereum provides a decentralized network for running resilient, secure, and borderless applications. While Ethereum enables the world computer, the majority of transactions are still tied to the real financial world. Bills, insurance, and everyday expenses are still primarily paid in fiat. Complex financial products and commodities, as well as all domestic transactions, are still denominated in US Dollars. With cryptocurrency volatility persisting, having a solution where one gets fiat price stability and blockchain technology is an essential component in the development of the global digital financial ecosystem.

How do stablecoins solve this problem?

Source CMC

Collateralized Stablecoins

Fiat-backed

Example: TUSD, GUSD, USDC, PAX, USDT

Asset-backed

Example: Digix

Crypto-backed

Example: DAI

Non-collateralized Stablecoins

Algorithmic

Example: Basis

What do stablecoins enable?

What comes next?

The next generation of currency, payment, and settlement will undoubtedly occur in digital form. The composition of the initial attempts gives us an idea of where this technology can go. Fiat-backed currencies offer familiarity and ideological comfort of 1:1 backing of the underlying pegged currency. Although introducing centralized risk, they serve an important function to familiarize and build trust with newcomers to the digital ecosystem.

The next generation of currency should allow alternative pegging so that they can be shielded from extraordinary events. Ideally, it should be backed by a diversified uncorrelated basket of assets to avoid effects of such events. Additionally, an ideal stablecoin would execute smart contract logic on-chain and be backed by decentralized assets. Each of the first attempts highlighted above successfully accomplish essential tasks in this development. With certainty, the next evolution in stablecoins is coming.

Thanks for reading ...