A stablecoin is a cryptocurrency or digital asset that is pecked to another stable asset. Stablecoins were introduced to solve the problem of volatility by providing asset backing for a cryptocurrency, protecting the value of the currency. In this article will explore the use of stablecoins and various types of stable coins.

What is the need for a Stablecoin?

The cryptocurrency world has seen a lot of ups and downs in regards to price and valuation. The level of volatility is enormous and cannot be predicted in any way. For instance, in 2018, the entire cryptocurrency market moved from a global market capitalization of $800 billion USD to $104 billion USD in the same year representing 87% loss in value.

The price action of the two biggest cryptocurrencies by market capitalization Bitcoin and Ethereum, within 2017 and 2018 is another example of high volatility in the cryptocurrency ecosystem. Between this period, Bitcoin started at $1,630 USD, then moved to $880 USD and as high as $19,000 USD moving downward again to $3,300 USD.

Ethereum has also experienced high volatility recording over a 100% loss after falling from an all-time high of $1,333 USD in January 2018 to $95 USD in December of the same year.

Such currency risk has been an obstacle to mass adoption of cryptocurrencies since its volatile nature serves as a hindrance in offering services such as blockchain based loans, prediction markets, and derivatives. In short, the extreme level of price and value unpredictability makes cryptocurrencies difficult to transact with. With the mass adoption of cryptocurrencies built around price stability, stablecoins presents a solution.

How does a Stablecoins Work?

Stablecoins generally have their market price pegged to that of another stable asset. There are three types of stable coins which include, Fiat-collateralized, crypto-collateralized, and non-collateralized coins.

A Fiat-collateralized stablecoin is a cryptocurrency that is backed by a traditional currency like the USD, EUR, SGD, etc. For instance, a stablecoin pegged to the EURO will be issued in a 1:1 ratio according to reserves stored in a bank.

When an individual chooses to withdraw their stablecoin, the coin is destroyed and the exact amount is given to the user. Fiat-collateralized stablecoins provides a digital representation of traditional currencies.

Examples of such stablecoins are Tether, TrueUSD, USD Coin, Singapore Dollar Rate, Paxos Token Standard, and Gemini Dollar.

Crypto-collateralized stablecoins, on the other hand, run in a similar way as their FIAT counterparts are backed by cryptocurrencies instead. This is a more decentralized alternative since all transactions remain on the blockchain. A crypto-collateralized stablecoin still has to battle with stability issues since the market price of the collateral is not stable.

To solve this, such coins are over-collateralized meaning for ever dollar of the stablecoin there is over a dollar of cryptocurrency in the reserve depending on the level of volatility of the cryptocurrency. The most popular ion this category is DAI.

Non-collateralized coins do not rely on any collateral. The idea is to code money into smart contracts to act as banks using oracles as observers. Non-collateralized coins promise a more decentralized and independent option among the three.

Though an interesting concept, there is very little development in this category of stablecoins.

A stablecoin provides a solution to the problem of volatility in cryptocurrency usage, but some experts argue it does this by taken aware of some of the values and ethics behind the creation of cryptocurrencies.

Despite its critics, this new asset class of cryptocurrencies continues to grow and provides a peek into the future of cryptocurrencies.

Liked what you read? Want to stay informed with the latest news and trends in the cryptocurrency world? Subscribe to our Newsletter.