What Is a Stablecoin?
Stablecoins serve as a much-needed antidote to price volatility in the cryptocurrency markets.
Let’s look at how they work, shall we?
Most of these digital currencies are collateralized by an underlying asset to deliver price stability.
For example, one of the most common types of stablecoins are those pegged to fiat currencies.
A stablecoin such as Tether (otherwise known as USDT) is backed on a 1:1 basis with the U.S. dollar. For every single unit of USDT that’s in circulation, $1 is supposed to be set aside and held in reserve by financial service providers. Alternatives include TrueUSD (TUSD) and USD Coin (USDC.)
The number of stablecoins out there has exploded in recent years — as well as the quantity. It’s also possible to find crypto assets that are pegged to other fiat currencies such as the euro, and even other cryptoassets!
It seems that the possibilities are endless with this new technology. Some stablecoin projects have tied their digital assets to precious metals, or to other cryptocurrencies. Projects such as Facebook’s Libra intend to allow stablecoins to be used as a medium of exchange — backed by a basket of different national currencies.
Stablecoins are exceedingly easy to buy, and are listed on most cryptocurrency exchanges, including Binance and Coinbase.
What Are the Main Use Cases for Stablecoins?
Trading volumes for stablecoins are increasing — and there’s a lot of real-world use cases for token holders to get excited about.
For example, at present, many financial institutions often charge astronomical transaction fees when cross-border transfers are being made or one fiat currency is being converted for another — and settlements can take days. Popular stablecoins allow transfers to happen instantaneously on the blockchain, and far more cheaply.
Picking the right type of stablecoins can also serve as a much-needed safe haven against short-term price volatility in the Bitcoin market.
Even some of the world’s biggest economies are looking into launching new stablecoins — often referred to as central bank digital currencies, or CBDCs. For financial institutions including the People’s Bank of China and the Bank of England, blockchain technology is becoming an increasingly important part of monetary policy. Many of these organizations hope on-chain transactions could deliver much-needed modernization, especially as smartphone wallets begin to become more popular than bank accounts.
The Disadvantages of Stablecoins
Whereas cryptocurrencies such as BTC are fully decentralized, the same can’t really be said for stablecoins because of how underlying assets need to be held in reserve. A big challenge is ensuring that these digital currencies are properly collateralized — indeed, Tether has faced legal action in New York following claims that USDT may not be backed 1:1 with the U.S. dollar.
Then there’s the tricky issue surrounding regulation. Many central banks reacted with some alarm when Facebook unveiled Libra, fearing that this crypto-asset could undermine the sovereignty of fiat currencies and even trigger an economic crash.
Ultimately, it may be some time before stablecoins achieve widespread adoption in the real world.