As the name suggests, a stablecoin is a cryptocurrency that guarantees the stability of its value. Widely used on cryptocurrency exchange platforms, stablecoins have recently attracted a lot of interest from the European Central Bank. What is a stablecoin? How do they work? What are they used for? What future do they have?
Pegged to the dollar, the USDT stablecoin from the company Tether is the most widely used stablecoin in the cryptocurrency market. 1 USDT = $1. Stablecoins are not all tied to fiat currencies. Others are backed by commodities or other crypto-currencies.
Stablecoins were created to protect holders from the volatility of the cryptocurrency market by offering tokens issued on a blockchain and indexed to stable assets.
What are the different types of stablecoin?
The 3 different types of stablecoins are stablecoins attached to:
This is the most common type of stablecoin. The first stablecoin linked to a fiat currency appeared in 2015. The USDT guarantees each of these tokens a unit value of one dollar. Its price does not fluctuate. For every USDT issued, Tether guarantees one dollar held in its vaults. It is therefore possible, in theory, to exchange this token with Tether for a dollar at any time.
Less commonly used, commodity stablecoins are based on the same principle as fiat currency stablecoins. Because it is a precious metal and an undeniable store of value, gold is often used to guarantee the value of these stablecoins. Example: 1 stablecoin = 1 gram of gold. The physical gold used as collateral for stablecoins is usually stored in the vaults of a trusted third party.
Less stable than the first two stablecoins are stablecoins whose value is indexed to other cryptocurrencies. Because they are backed by other cryptocurrencies, these stablecoins are much more decentralized. The Maker DAO project and its stablecoin DAI, which is pegged to the Ethereum blockchain cryptocurrency Ether, is the best known stablecoin of its kind.
To compensate for the lack of stability that indexing to crypto-currencies provides compared to indexing to fiat or commodity currencies, these stablecoins practice what is known as reserve overcollateralization. That is, the Ethers in reserve must be greater than the number of IADs issued in the market. In this way, the reserves can absorb the volatility of the cryptocurrencies.
Stablecoins allow you to:
As we have seen, indexing to a stable currency or commodity guarantees the stability of a stablecoin.
Whether you are an investor, trader or a business in the crypto industry, stablecoins are the best way to convert your crypto earnings into fiat currency today. It can be risky for you to keep all your capital in cryptocurrencies, especially if the Bitcoin price collapses by 80% in a few days.
When you transfer your cryptos in fiat currency to the traditional system via a 50-year-old interbank system like SWIFT, it inevitably becomes slow and expensive. Stablecoin transfers taking place on a blockchain are considerably faster, cheaper and more transparent
Except for Maker DAO’s DAI stablecoin, the use of stablecoins implies full trust by users in a centralized authority to hold the underlying asset on which the stablecoin is based.
The vast majority of stablecoins require trust in a third party to store the collateralized currency.
The company may lie about the funds it has in these reserves. As was the case with the Tether controversy
Stablecoins are great for converting your crypto earnings into a safe haven that is not subject to the fluctuations of the cryptocurrency market. In a report released on August 25, CoinMetrics revealed that the average amount of money traded in Tether stablecoin now exceeds that traded on PayPal and Bitcoin.
This trend can be explained by the boom in the decentralized finance ecosystem (DeFI). Indeed, stablecoins are very often used to buy DeFI tokens. Their adaptation will accelerate over time, but it remains to be seen how central banks and governments will deal with the emergence of this new form of currency.