What sets stablecoins apart and why to consider them in the future

28 December 2022

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The crypto space is vast – terms such as cryptocurrencies, NFTs, security tokens, CBDCs, and stablecoins have entered the vocabulary of connoisseurs and amateurs alike. Stablecoins, in particular, seem to be in the spotlight, so if you’re looking for more explanations regarding their meaning and use, you’ve come to the right place.

Cryptocurrency is undoubtedly the most common digital asset and a top investment choice among individuals. And although there’s nothing wrong if you buy Bitcoin online after checking the current Bitcoin price, we highly encourage you to broaden your knowledge about digital currency, as well as your investment portfolio. A great alternative to virtual currencies like Bitcoin and Ethereum is given by stablecoins, famous for their stability and versatility. Stablecoins are a valuable tool for investors and traders, giving them the best of both crypto and fiat currency. Stablecoins are here to make cryptocurrency more ‘predictable’ – if we could say so – countering the ever-present volatility and giving people convenience when paying for daily goods. At the same time, they help traders conserve their fiat value without being forced to convert their crypto into cash and thus handle the sometimes-pricy transaction fees.

For more insight into this fascinating digital asset type, keep reading!

First things first – What are stablecoins?

Stablecoins are a type of cryptocurrency that reflects another asset, such as a commodity, debt instrument, or another currency – dollar, euro, pound, rupee, etc. These coins are often perceived as a valuable crypto-equivalent to fiat currency. It has become the center of attention lately, especially for investors looking to preserve their asset value and maintain their position in this sometimes-deceptive crypto game. The high volatility defining many digital currencies on the market, including Bitcoin and Ethereum, is a major impediment in this sense, so the need for a solution has never been greater. Fortunately, stablecoins peg their market value to commodities like gold and big-name currencies like the US dollar, so they inevitably hold over-time value similar to fiat currencies.

Why are stablecoins so special?

The rise of stablecoins has been welcomed cheerfully by investors, as the assets made it reachable for them to cash out instantly and peacefully. Not only did it become easier to move money, but it also facilitated purchasing and trading.

Even if virtual currencies such as Bitcoin and Tether are major players in the crypto space, they’re characterized by volatility and, hence, uncertainty. A high volatility translates into a meteoric price fluctuation in either direction, while a low volatility indicates a relatively stable asset price. Preferably, you should buy the crypto when the price is low and sell it when the price rises – a strategy referred to as ‘buy the dip and sell the rip’ – but things don’t always happen as expected, especially if you’re a beginner. So, advisably, you should look to minimize the risks. Don’t get us wrong – volatility can be great if you predict the market properly. Still, it transforms monotonous transactions such as purchases into speculation with a considerable risk of losing value.

To serve as a currency, a digital asset must be – first and foremost – a medium of exchange. On the other hand, to act as a medium of exchange, crypto that hasn’t been adopted as legal tender should maintain relatively stable, promising those embracing it that it’ll preserve buying value. That means it can be used to value services and products and simplify e-commerce. Stablecoins can be used as mediums of exchange, which is the technology’s most prominent benefit. The fact that they connect crypto and fiat currencies in such an advantageous manner makes stablecoins real-utility assets that have great chances of becoming adopted globally.

Types of stablecoins

Stablecoins can be categorized into four main types, depending on the mechanism used to fix the value of a particular token:

Fiat-collateralized/backed stablecoins

Fiat-backed stablecoins keep reserves in fiat currencies, just as their name indicates. For each USD in circulation, for example, these stablecoins usually have one dollar reserved – either in cash or cash alternatives – ensuring thus their value. Most fiat-backed stablecoins have reserves of USD, but there are also stablecoin reserves in pound sterling, Chinese RMD, Japanese yen, and, of course, the euro.

Cryptocurrency-collateralized stablecoins

Crypto-collateralized stablecoins are, obviously, backed by more established virtual currencies. Given the often-high volatility of this type of asset, crypto-backed stablecoins are typically overcollateralized, meaning that the value of the stablecoin emitted tends to be eclipsed by the value of the crypto kept in reserves. MakerDAO, for example, is one of the most prominent crypto-baked stablecoins. It relies on a smart contract – a sort of code-based, self-executing contract – on the Ethereum platform to merge enough ETH, Ethereum’s native currency. It aims to reach enough collateral ETH so people can further mint DAI.

Commodity-collateralized stablecoins

Other forms of collateral refer to commodities like real estate and oil, as well as precious metals like gold and silver. Gold is, interestingly, the most frequently collateralized commodity, as users are interested in investing in an asset that might otherwise be unreachable to a certain degree. Besides, users are allured by the option of gold-backed stablecoins, as it makes it possible for them to hold gold without the inconvenience of storing and sourcing it.

Algorithmic/hybrid stablecoins

This is a special type of stablecoin, as no real commodity or currency backs it. In fact, it depends on complex algorithms to control its supply. Simply put, these algorithms are basically computer programs running a predetermined formula that eventually burn automatically, eliminating coins from circulation for good.

Popular stablecoins to keep an eye on

Since the launch of the first stable coin – BitUSD – in 2014, several such coins have come into being and are now issued as tokens on a range of blockchain platforms. Tether, Dai, and many more have thus followed the pioneering stablecoin. Blockchains that emit stablecoins also support Decentralized Finance (DeFi) technology and smart contracts.

If you’re looking to diversify your portfolio, consider investing in these stablecoins: