The Era of Stablecoins: A New Wave in Crypto Adoption
While stablecoins have many characteristics in common with crypto assets, they also aim to stabilize the price of the “currency” by connecting it to the value of a bunch of assets. Stablecoins may be better suited to acting as a medium of exchange and a store of value. They may help pave the way for creating global payment systems that are quicker, more affordable, and more inclusive than current systems. Stablecoins, however, are simply one of the several initiatives that aim to address current problems with the payment system, and as a young technology, they have not been extensively tested. But what exactly are stablecoins? Let’s find out.
A stablecoin is a cryptocurrency that bases its value on a more reliable asset. Stablecoins can have value tied to precious metals, fiat currencies, or other cryptocurrencies, but most typically, people refer to them as being connected to a fiat currency, such as the U.S. dollar. In essence, stablecoins are a less volatile form of cryptocurrency with a greater chance of resembling the currencies people already use daily.
Midway through June, the share of stablecoin holdings in the value of the entire crypto market reached a record high, making up 14% of the entire cryptocurrency market on June 14. This is an increase from about 2% in January 2020 and far higher than the previous high of 11 % reached in January 2022. According to estimates, stablecoins now account for 17% of the overall market comprising $155 billion in value.
Types of Stablecoins
There are three categories of stablecoins:
Fiat-based: Fiat money is frequently used as a peg in fiat-based stablecoins to assure stability. Tether (USDT) is the most liquid US dollar-backed stablecoin because it has the highest market capitalisation. It is also used by practically all cryptocurrency exchanges globally.
Commodity-backed: Physical assets such as precious metals, oil, and real estate are used as collateral for commodity-backed stablecoins. Gold is the most frequently collateralized commodity. For example, Pax Gold (PAXG) uses one fine troy ounce (t oz) of a 400 oz London Good Delivery gold bar as collateral for each token and is kept in Brink’s vaults.
Crypto-collateralized: Stablecoins supported by other cryptocurrencies are known as cryptocurrency-backed stablecoins. These stablecoins can be designed to follow the value of supporting cryptocurrencies. Maker Dai (DAI), the largest cryptocurrency-collateralized stablecoin, is still in use. ETH and MKR are the two coins supporting DAI.
Algorithmic: Algorithmic stablecoins rely on rules incorporated into the coin’s software code to balance the market supply and demand for the currency. Examples of algorithmic or non-collateralized stablecoins include Kowala and Ampleforth. Their systems effectively maintain stability by automatically adjusting supply levels.
Terra UST was an algorithmic stablecoin. In Early May, Terra stablecoin lost its peg to the US dollar, and within a few days, it went down to a fraction of pennies.
People are unsure whether they can trust cryptocurrency initiatives in light of the recent collapse of Terra. The Terra UST crisis sent the cryptocurrency market into a death spiral, which in turn drove many of the projects linked to it to the brink of bankruptcy.
Like anything else, stablecoins possess their share of pros and cons. Let’s know more about them.
What are the Pros of Stablecoins?
Stable in value: Stablecoins are digital currencies with a constant value as opposed to Bitcoin, Ethereum, and Dogecoin, making them more appropriate for everyday transactions.
Simple to trade: You may quickly and easily exchange stablecoins for other cryptocurrencies.
Useful for sending funds: Stablecoins can be used to send funds to anyone with a suitable cryptocurrency wallet without incurring additional bank fees or levies (network fees may still apply).
What are the Cons of Stablecoins?
- It calls for third-party trust confidence from an entity.
- There is a need for external audits to guarantee that all assets are accounted for.
- Allow a lower return on investment.
- Some regulations and processes related to fiat have to be complied with.
Is Stablecoins the Future?
Since cryptocurrencies are frequently highly volatile, you may need to preserve your digital assets in stablecoins if you do not know about blockchain technology and are unsure how to respond to changes in market conditions.
It is a fairly considerable idea to protect and preserve your digital assets in stablecoins if you cannot maintain a careful eye on market circumstances or developments or if you are just unfamiliar with them.
Additionally, cryptocurrencies may experience a “bearish” recession where the value of all cryptocurrencies drops sharply. You can reduce your exposure to risk during these times by changing your digital assets into stablecoins.
Stablecoins are becoming overly popular as the number of cryptocurrencies increases exponentially. The stablecoins will continue their inescapable integration in the crypto market, given their track record of performance and the breadth of their infrastructure.
Do you need Stablecoins?
Bitcoin traders and investors do not typically require stablecoins. However, they are helpful for temporarily withdrawing money from more volatile cryptocurrencies and exchanging between various cryptocurrencies. Additionally, investors may occasionally discover that stablecoins’ consistent value is handy for everyday transactions. Stablecoins are probably not a smart long-term investment for those looking to make big profits but can serve as a good store of value or hedge against volatility.