The purpose of stablecoins is to maintain price stability and bridge the gap between fiat money and cryptocurrencies. They are linked to traditional assets, such as paper money or gold, making them a relatively less volatile alternative than typical cryptocurrencies. Promising faster transactions and lower costs, stablecoins are an alternative to traditional banking solutions.
They allow traders to keep their money in the crypto ecosystem while storing it in a stable asset between trades or during volatile periods. Stable coins are not risk-free. Some algorithmic stablecoins may fall in value.
What are stablecoins?
Stablecoins are cryptocurrencies whose exchange rate is pegged to a specific asset, most often, but not always, the US dollar. It is well known that the price of cryptocurrencies can rise and fall dramatically in a short period of time. Recalling the Bitcoin (BTC) almost doubled to its historic value in February 2021, rising from around $32 000 to $58 800. However, the price fell dramatically three months later, in May 2021, to around USD 34 000.
Such fluctuations, or so-called "short-term volatility", make cryptocurrencies unfavourable for everyday use by the public.
By maintaining value and purchasing power, pegging to an asset can make stablecoins more resilient to market fluctuations in cryptocurrencies. For example, one of the most popular stablecoins - Tether (USDT) - is usually equivalent to USD 1. Other popular stablecoins are USD Coin (USDC) and Dai (DAI).
Unlike typical cryptocurrencies, stablecoins not only have significantly lower volatility due to their asset-based nature, but also play a bridging role in the world of cryptocurrencies and fiat money to facilitate daily trading transactions and exchanges.
The advantages of stablecoins are:
- Lower volatility
- Lower transaction costs
- Safer ways to store funds in the crypto ecosystem
- Real time payments
These advantages make stablecoins more competitive than other cryptocurrencies, as they alleviate many consumer and business pain points. Currently, BTC and other cryptocurrencies cannot offer the same level of stability and scalability for real-time transactions as stablecoins.
With the total market capitalisation of all the world's stablecoins reaching more than half of global crypto trading volume, the DeFi have become an important asset for the ecosystem.
What are stablecoins used for?
There are four types of stablecoin:
- Fiat backed stablecoins (most popular)
- Crypto-backed stablecoins
- Commodity stablecoins
- Unhedged stablecoins
The primary use of stablecoin is to facilitate trading on crypto exchanges. Instead of buying BTC directly with fiat money, such as Hungarian forints, traders often exchange their fiat money for a stablecoin. They then trade the stabilcoin for another cryptocurrency, say BTC.
Stablecoins can also act as payment alternatives to fiat currencies. Using stablecoins, businesses can accept payments at very low cost and governments can run conditional cash transfer programmes more smoothly. Thanks to their high transaction speeds, stablecoins can also be used to quickly deliver cash aid to beneficiaries around the world.
Another use of stablecoins is to send money across international borders. They can be exchanged between individuals in different countries for cross-border money transfers without third-party fees.
Are stablecoins safe?
A common concern about stablecoins is whether they are safe and can be relied on as an alternative to fiat. There are two things that market participants need to consider. First, do the classic crypto advice on DYOR before investing money. Check in detail the issuing entity, its history and its previous projects before buying its stablecoins. Secondly, if in doubt, users can transfer their funds to other stablecoins or even other cryptocurrencies.
