Amid a collapse in the digital asset market in 2018, which saw Bitcoin lose 80 percent of its value, many investors have moved into stablecoins – the “holy grail” of cryptocurrencies. Here is what you need to know about stablecoins.
What is a stablecoin?
A stablecoin is a cryptocurrency pegged to another stable asset such as gold or the US dollar. While conventional digital money like bitcoin is highly volatile, stablecoins are generally traded at a fixed price.
Why are they useful?
Right now, stablecoins typically serve as a gateway for investors to enter the crypto-asset market.
Most cryptocurrency exchanges in the world only allow users to trade one digital token for another. That is because converting fiat currencies into cryptocurrencies is a relatively complicated matter, which involves dealing with banks and regulators in different jurisdictions.
If you want to buy a cryptocurrency for the first time, one of the easiest ways to do so is to turn your money into stablecoins via fiat-to-crypto exchanges, such as US-based Coinbase and Hong Kong-based Coinsuper. With your stablecoins, you can then jump onto bigger platforms like Binance, where you can trade hundreds of digital tokens.
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If you decide to exit digital tokens because of volatility or another reason, you can trade them back for stablecoins without having to move any money back to the fiat world.
But the use cases for stablecoins go beyond being a simple gateway to the trading of digital tokens. Stablecoins can be used for everyday transactions such as buying coffee, paying salaries, or buying real estate. They face fewer barriers to mass adoption than traditional cryptocurrencies, which often come with low transaction speeds and high fees in addition to current volatility.
What are the different types of stablecoins?
The most common type of stablecoin is backed by US dollars or other fiat currencies at a 1:1 ratio. The coin issuers hold the same amount of fiat money in their bank accounts. Think of them as IOUs redeemable for the underlying assets.
The market leader in this category is Tether or USTD issued by the US-based startup Tether Limited. However, after the company failed to provide an independent audit report, the price of Tether dipped to US$0.90 in October 2018 and investors questioned whether it is fully backed by US dollars. Still, Tether remains one of the most traded cryptocurrencies with a market value of US$2 billion.
Rival US dollar-backed stablecoins such as Gemini, TrueUSD, USDC, and Pax are issued by companies regulated in the US, and auditing is generally more transparent. All these offerings are available on most exchanges.
The second type of stablecoin is still pegged to the US dollar at a 1:1 ratio, but the underlying collateral is another cryptocurrency such as Ether. Every step of coin issuance is completed via a set of protocols executed on blockchains. A cryptocurrency investor is required to deposit or lock up an amount of Ether that is worth more than the stablecoin they will get in return. The overcollateralization is intended to act as a buffer to daily price swings in Ether.
There is no auditing required because everything happens on the blockchain. Popular examples include MakerDAO’s DAI and Havven’s nUSD.
The third model has no collateral at all. As crazy as the idea might sound, these stablecoins use blockchain-based algorithms as a kind of central bank, whose sole purpose is to control the “money supply” to make sure the coins will always trade at US$1. Examples of algorithmic stablecoins include Basis and CarbonUSD.
What is next for stable coins?
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