What is a Stablecoin? - Reading time: about 6 minutes
A stablecoin is a form of cryptocurrency that is designed to bridge the gap between volatile traditional cryptocurrencies like Bitcoin and more stable, real-world assets such as fiat currencies. A stablecoin is considered to be the blockchain-based version of fiat currencies (government-backed real-world currencies) and it is due to this that the USD-denominated variety are often referred to as “digital dollars.”
TLDR: In essence, stablecoins represent an asset class that combines a bit of both worlds - the programmability, security, and rapidity of cryptocurrencies and the non-volatile stable price of fiat currencies.
Blockchain continues to change the global economy with its potential to enable a decentralized future that is devoid of middlemen or any form of intermediaries. As a result, cryptocurrencies have been growing in relevance and importance in the past decade, particularly with the evolution of industry-related concepts like decentralized finance (or DeFi) - the emerging, and fully automated financial services developing on blockchain technology.
However, they continue to fluctuate in value. While the fluctuation - the changing values of cryptocurrencies over time - indicates an investment opportunity for some, it portends risk for other public users.
Stablecoins play a major role in reducing this associated risk, helping users park their capital into stable-value assets over longer periods. Using stablecoins also widens access to inclusive financial services alongside novel use cases such as money markets and accruing yield, or interest.
Blockchain, once a relatively nascent technology, has the potential to disrupt virtually every major global sector - based on the core properties of truth, trust, and freedom - making stablecoins even more relevant to power the emerging decentralized Internet and its future.
Unlike other cryptocurrencies, though, stablecoins are controlled by centralized organizations which inherently makes them susceptible to regulatory oversight.
Why use a Stablecoin?
Stablecoins serve several useful purposes which mostly hinge on their premise of being resistant to volatility and maintaining stable value, primarily to an underlying peg. They include the following:
As a medium of exchange
Due to their being pegged to a stable asset makes them ideal as a cross-border medium of exchange. Stablecoins provide a crypto-fiat rail for all transacting parties in a commercial transaction with the added convenience of accepting and holding this asset class for current and future uses.
- Store of value
Any fluctuations affecting stablecoins tend to fall in a tight range and are therefore predictable. This represents their primary use as a store of value due to an inherent ability to maintain its underlying value, making them particularly useful for unstable, inflation-prone economies or where citizens have been restricted from using foreign currencies. Consequently, stablecoins serve as hedge assets for wealth preservation. In the crypto space, users can park their volatile assets into stablecoins, especially in a period of a downward trend in market prices (bear market).
- Entry and HODL
Crypto traders use stablecoins to buy other cryptocurrencies on trading platforms like exchanges where they do not offer trading pairs with fiat currency. A trader seeking to enter and exit from cryptocurrency investments can simply turn to stablecoins to avoid dealing with multiple transfers and compounding trading fees.
- In-real-life (IRL) payments
At a time when stablecoins have started to gain the interest of many across the world, including governments which are considering adding them to their fold as an acceptable method of payment, they stand out as a better choice for the majority to use for payment purposes and business transactions.
What are the main types of stablecoins?
Stablecoins come in a wide variety as increasingly novel mechanisms are introduced to find an efficient pegging mechanism. Some of these examples are characterized by sustained success while others have crashed and burned in spectacular fashion.
Fiat-pegged (predominantly USD)
These are stablecoins that are backed by a fiat currency like the U.S. dollar. In this category, the fiat currency that backs the stablecoin on a 1:1 basis will remain an off-chain asset - not in any way linked to another traditional cryptocurrency - backed by a reserve and issued by a centralized institution.
The symbiotic relationship between a fiat-pegged stablecoin and the currency backing it requires that the amount of the stablecoin token in circulation must be in tandem with the amount of the fiat in reserve — either in cash or cash equivalents. The biggest and most well-known stablecoins in this category are USDT and USDC.
Unlike fiat-pegged stablecoins, crypto collateral-based stablecoins are those backed by traditional cryptocurrencies hence decentralized in all forms and open to risk distribution. To withstand fluctuations that could arise from their dependence on cryptocurrencies and their inherent volatility, crypto collateral-based stablecoins are typically over-collateralized i.e. the value of the underlying collateral must exceed the value of the corresponding stablecoin token in circulation.
This is to ensure they maintain their peg and also provides a safety net for users posting collateral even in the face of market volatility as it affects underlying cryptocurrencies.
A good example in this category of stablecoins is MakerDAO’s DAI which is currently backed and stable against Ether (ETH) at a minimum 150% collateralization ratio.
Pegged to - but not backed by - the value of a real-world asset, this category of stablecoins depends on on-chain algorithms to keep their prices stable. The algorithm enables the stablecoin to maintain a consistent value and usually link two coins - the stablecoin itself and a related token that backs the stablecoin.
Usually undercollateralized with no particular reserves backing their values, algorithmic stablecoins are programmed to be instructed by specialized algorithms (or smart contracts) that manage their circulating token supply in line with market demand.
Algo stables also come in multiple varieties:
The most prominent model utilized by algo stablecoins is one that incorporates a fixed rate, generally 1:1 and relies on arbitrage to maintain its peg. If one side of the rate drops below 1, a trader can simply redeem the appreciated asset for the depreciated asset and pocket the gain.
While this model can potentially be sustainable during stages of market growth, the death spiral of UST following its depegging has thrown the viability of this model into question.
The algorithms adjust the number of their circulating tokens as the market price of the fiat currency they track falls below or rises above its actual price.
Rebase tokens (also known as elastic tokens) are a form of algorithmic stablecoins that control the supply of a coin to maintain its value.
They are usually pegged to another asset but will either mint new tokens (rebase) or burn existing tokens (debase) - according to the price movement of the stablecoin - to maintain its value when the price of the stablecoin rises above or below its actual value. Rebase tokens are highly volatile owing to price fluctuations. Their supply is not capped.
One of the first rebase tokens was Ampleforth which was originally named Fragments and features a daily rebase that is triggered when the price target is lower than the oracle rate. Conversely, a debase would burn tokens when the price target exceeded that of the oracle rate.
Another recent rebase token is USDD, which is pegged to USD and claims to be the first over-collateralized decentralized stablecoin based on its BTC, USDT, and TRX reserves.
An example of a fractionalized algo stablecoin is Titan, which resulted in a death spiral as well as the open-source fractional-algorithmic stablecoin, FRAX.
Most commonly used stablecoins:
How to buy stablecoins on ProBit Global
1) ProBit Global users can buy USDT, USDC, and DAI using a credit card by accessing the fiat-on ramp which currently supports over 40 fiat currencies.
2) Stablecoins can also be purchased on the exchange by placing a limit order.