Everything You Need to Know About Stablecoins

After the booming success and sensation that Bitcoin and Ethereum have recently enjoyed, the concept of cryptocurrency quickly progressed into the mainstream.

Initially understandable only to people with professional software engineering knowledge, crypto-assets are now actively traded and exchanged online, with the market exceeding $1 billion in 2019 and expected to grow to $1.4 billion by 2024. The crypto market is one of the most actively developing ones today, with an annual CAGR of 11.2% predicted by 2027.

But are all crypto-coins so predictable in terms of value and dynamics? Unfortunately, for most of them, their key advantage (absence of reliance on any fiat currency or other legit financial asset) can also be considered as their downside, allowing unthinkable price fluctuations. As a result, the cryptocurrency owners can get rich overnight or can lose everything at the same lightning speed.

The solution to the problem of cryptocurrency volatility has been found in the brand-new type of crypto-assets – stable coins. Read on to find out about what stablecoins are, how they differ from regular cryptocurrency, what kinds of them exist, and how they’re moving into mainstream finance.

Read also: Polkadot vs cardano

What is a stablecoin?

Major cryptocurrencies like Bitcoin, Ethereum, or NEO have gained much publicity since 2017, the turning point at which many crypto-assets enjoyed a price explosion. But because of such price ups and downs, too few serious investors could afford to hold cryptocurrency for an extended period, making this form of currency unsuitable even for medium-term investment.

That problem emerged from the absence of any currency’s relation to fiat money, precious metals, or other financial instruments that would allow fixing their prices. The emergence of stablecoins solved the problem. These crypto-coins exhibit a much higher level of price stability because of their initial linkage to fiat currencies and mimicking of the financial systems supporting national currencies’ stability.

The benefit of stable cryptocurrency is in the creation of a specific ecosystem enabling the redemption and stabilization of coin value, minimum to zero fees incurred by users transferring coins, and hassle-free interaction with users. The stable coin’s value is typically tied to an asset or a portfolio of assets as a tool for its value stabilization. Thus, they follow a much more stable, predictable exchange rate policy.

Read also: Initial coin offerings

How do stablecoins work?

At present, the G7 Working Group on Stablecoins determined three models of stable crypto coins market follows. The first model presupposes issuing a stable coin with a face value fixed in relation to a commonly used unit of account (it may be any fiat currency or a set of governmental financial obligations).

Following this model, users purchase coins from the issuer at a fixed price and receive a pledge from the issuer about the redemption of all coins at the same fixed price if anything goes wrong. Such stablecoins possess a reasonable degree of liquidity.

The second model presupposes issuing a crypto-asset without a fixed face value, but with a portion of the asset portfolio assigned to it. In this model, stablecoins function more like exchange-traded funds (ETFs), with the entire asset portfolio of the coin issuer divided by the number of coins it issues, and the value of those coins fluctuating along with the changes of the ETF’s total value.

In the third model, the coin’s value is backed by the claim against the issuer. In this case, only public trust to the issuer serves as a guarantee behind it, and the public regulates the coin’s price with the help of the set of trading and exchange actions they undertake with the assets they own. This model presents an opportunity for individuals or organizations to create a stablecoin by establishing public trust in the issuer and implementing mechanisms to maintain price stability.

Major insights on stablecoins implementation

Stablecoins could be classified into 2 major categories – custodial and non-custodial. Custodial stablecoin is fiat-backed which means there is a bank account that confirms the on-chain supply and such stable coins are censorable. They include several types:

• Regulated stablecoins ( like USDC and TUSD) which hold verifiable fund reserves.
• Unregulated stablecoins ( like USDT) that hold Fractional Reserves as they resemble a bank or money market fund.

This sort of stablecoin faces bank-run-like de-pegging risks. Therefore, unregulated stablecoins are riskier for users that need a censorship-resistant store of value.

Non-custodial stablecoins category includes stablecoins that are algorithmically backed by collateral. The issuance of such coins is regulated by a complex system that includes smart contracts and other crypto-assets as collateral. The peg is maintained by the market and ecosystem player. The economic structure of the basis of stable crypto value foremost depends on market expectations in some systems. There are three types:

• Exogenous collateral (used outside of the stablecoin system like ETH with Maker)
• Endogenous collateral (created to be collateral for a stablecoin)
• Implicit collateral (where market mechanisms are used to dynamically adjust supply to stabilize the price).

More stable cryptocurrency examples

So, what’s the best big thing after Bitcoin? What coins can be regarded as stable, giving more price prediction and investment opportunities for those interested in crypto investments? Let’s consider the most stable coins that users rank highly today in terms of trustworthiness and perceived potential.

One of the most popular stablecoins is Tether (USDT). It was designed with a value meant to mimic the value of USD, so it’s mostly used as a digital dollar equivalent. Its price fluctuates slightly around $1 per one USDT, and the market cap of USDT in circulation is around $10 billion. It’s highly popular online, and some blockchain experts even dubbed it as the next Bitcoin.

The second-largest stable coin today is USD coin (USDC). It is priced a bit higher than USDT, but there is only $1.29 billion USDC in circulation as of 2020. The benefit of USDC is its backing with USD currency held in reserve. The issuer of USDC is a Centre Consortium, including the crypto-exchange Coinbase and the Bitcoin mining giant Bitmain.

The Dai stable coin (DAI) operates on the Ethereum platform and possesses unique technical and financial characteristics. With over $420 million in circulation, DAI has new CDP collateral types and Dai Savings Rate. Will it become the world’s next big cryptocurrency? Only time will show.

Some other popular stable coins well-established in the crypto-market include TrueUSD, Paxos Standards, Binance USD, and JUST. But these assets are mostly known as assets used for online-only transactions.

An example of real-life implementation of stable coins into broader financial transactions is the use of Terra and Luna in the Asian region. Terra is known to be the largest blockchain payment network in the world, boasting lower transaction fees, instant settlement, and ongoing special offers.

The face value of Terra is tied to a family of stable coins, which, in their turn, are pegged to the world’s major fiat currencies. Besides, the stability of the coin’s price is embedded into this coin’s blockchain, with Luna as a supportive currency circulating to stabilize all deviations and minimize volatility.

An AI algorithm weaved into Terra’s code controls the coin’s supply on the market to reduce or increase its value for the sake of stabilization.

With this list of stablecoins at hand, you can plan for investment in the industry. But it is still noteworthy that even stable coins can never promise 100% stability and predictability they claim to possess, as the absence of linkage to mainstream financial instruments or assets is still a source of potential volatility and elevated risks.

Why are stablecoins growing in popularity?

So, what are stablecoins for consumers, businesses, and governments, and what are the prospects of their use online and offline? The environment in which we live is highly conducive to greater adoption of crypto money for some reasons:

• A vast number of people still remain under- or unbanked, which means that they have little to no access to traditional financial instruments like credit and debit cards, loans, and investment. Experts of Finextra indicated that 1.7 billion people remained unbanked as of 2017, but with decentralized and more loyal digital currency systems, the unbanked population may get broader access to finance.
• The use of mainstream banking requires paying considerable fees to the official intermediaries. In this way, a cross-border money transaction usually presupposes paying around 3% fees to banks or card issuers. Digital currencies allow minimizing the expenditures on transactions, expected to reduce intermediary fees by $15-20 billion per year by 2022.
• Consumers grow more and more distrustful towards mainstream white label banks as the centralized system of finance is controlled by the government. Thus, people can hardly control or influence centralized financial systems, while in the blockchain-powered decentralized systems, they have more power and ownership.

Stablecoin implementation: cases and barriers

One of the bottlenecks for broader stablecoin adoption is the low level of acceptance by consumers and retailers. To date, only Starbucks and Overstock.com are known to accept some major cryptocurrencies as payments.

Xank experts also indicated that Nordstrom and Wholefoods had implemented the cryptocurrency processing gateways. So, the e-commerce industry is still far from the widespread crypto-asset support in transactions.

The most widespread barrier to acceptance of cryptocurrencies and stable coins by merchants is the absence of the required legal environment guiding such alternative financial transactions. Most governments are consensual that any kind of crypto money, including stablecoins, still presents severe risks to the health of national and international financial systems because of their decentralized regulation and absence of unitary ownership.

Thus, stablecoins, though possessing certain advantages as compared to regular cryptocurrencies, are still ranked low by official fiscal institutions, and their acceptance at the official level is yet to be considered.

Demand for stablecoins among consumers

Cryptocurrencies have spread around the globe at lightning speed, conquering the hearts of high-risk investors and tech geeks. Today, disruptive blockchain-based technology is increasingly used in a variety of areas, enabling even tech laypeople to embrace its vast potential.

The lack of proper understanding of cryptocurrency and stablecoins, as well as the technology lying behind them, still prevents its greater adoption among the population. However, the demand is on a steady increase, which is evident from the 40% increase in market capitalization of USDT, USDC, PAX, and BUSD since the start of 2020.

As Bitcoin news experts clarified it, stablecoins still require more trust from the public than fiat currency does. Major national currencies have existed for centuries, so they have a long-standing tradition and government’s guarantees behind them, which looks more stable from a conservative point of view.

Second, it’s vital to understand that the price stability of stablecoins depends primarily on the volatility of assets backing them. Thus, on the market of cryptocurrency, a certain degree of risk is still present for stablecoins’ face value in case of some major market fluctuations affecting the backing assets seriously.

What does the future hold for stablecoins?

As the experience of the previous three years has shown, cryptocurrency remains a highly popular and demanded asset in the increasingly digitized world. Such assets offer a healthy (though riskier) alternative to fiat currency, which becomes an anchor of stability for many people amid the global financial crises and pandemics. Thus, stablecoins definitely have all chances for success as more predictable varieties of highly volatile crypto assets.

Apart from the growing demand and market capitalization of such assets, one should still keep in mind that the drivers of their increasing adoption are many, and the frequent use of stablecoins for financial operations is possible only after several requirements are met.

These include, for instance, stable consumer demand for such assets, higher adoption of crypto payments by e-commerce giants, the use of safe, advanced technology guaranteeing the security of people’s funds, and an appropriate regulatory environment backing the use of crypto money.

At present, unfortunately, not all requirements are met as governments are still non-supportive of cryptocurrency. Besides, corporate champions are adopting cryptocurrency only as a form of experimentation rather than a mainstream payment option. Most barriers stem from the lack of technology maturity, and digital literacy, so greater adoption of stablecoins shortly is yet to be expected.

How to embrace the potential of stablecoins?

When it comes to generating a stablecoin of your own or buying some, all clients need expert knowledge in this sphere to act wisely. The high-tech world of cryptocurrency is too volatile and unpredictable for intuitive decisions, so expert advice and consultation should be the starting step in your crypto investment.

Talk to our specialists to find out more about blockchain and crypto, to choose a correct strategy, and to harness the enormous potential of this new currency alternative.