Stablecoins refer to those cryptocurrencies pegged to another currency. For example, the U.S. dollar or another financial instrument such as gold to provide an alternative to highly volatile cryptocurrencies such as Bitcoin. At times, one may feel insecure because of the volatility experienced in normal cryptocurrencies. As such, stablecoin came in as a critical component when decentralized finance the DeFi was developed.
This makes it possible for transactions to go through without the interference of middlemen and intermediaries such as financial institutions, including banks. The stablecoins that have done well in the industry include the USD coin and the Tether, which have garnered the highest capitalization in the crypto industries. Most major wallets have also incorporated these stablecoins because of their popularity and significant incorporation with real-world assets such as the U.S. dollar.
In most cases, if you join the cryptocurrency world besides trading, whether you intend to lend, borrow or seek financing, you will most likely come across these stablecoins. However, as you choose which one to work with, it is essential to know that they carry different values than normal cryptocurrencies. They are also subjected to regulatory scrutiny, and you must be a verified user to have them on board.
This article explains how stablecoins work; we will list these for your enlightening.
Stablecoins Definition
In an easier term, stablecoins is a cryptocurrency that was developed to offer a higher level of stability than other cryptocurrencies. To maintain these stabilities, some coins have a reserve of the asset that they represent, while others use algorithms. Apart from this, they also look for ways to help them from high volatility and give peace to investors in their trading activities.’
What is the Difference Between StableCoins and Other Cryptocurrencies?
One significant and notable difference is the volatility aspect. But there is a need to understand that both cryptos are based on similar blockchain technology to secure the ownership of the digital assets.
While the market value determines the value of cryptocurrencies, this is not so for stablecoins. They are developed so that they are not affected by the market rates, which is why they are linked to a real-world currency whose value hardly fluctuates. On the same note, if it fluctuates, the margin is immaterial.
Cryptocurrency Terms that you Should Know
Several terms are used in the crypto world, and it is vital to know them if you want to understand more about the Cryptocurrency experience.
- Blockchain– To have clear and verified transactions going through from one party to another, cryptocurrencies get powered by an open source, the Blockchain. This chain helps create a permanent link for any transaction, where one can view the status, and as such, hackers do not get a chance to access the chain.
- Decentralized- As mentioned, cryptocurrency is not regulated by any financial institution, such as banks. The crypto pioneers put it that regulation is creating financial barriers so that when they are centralized, one can only open a bank account during specified time zones. Decentralization broke such barriers, and one is free to send monies at liberty.
- Digital Wallet – A digital wallet is a program or app designed to hold cryptocurrencies. It is like the traditional banks where people have or save their monies and use them when in need. Crypto exchanges such as Coinbase can be described as a crypto wallets for storing and use at liberty.
How Stablecoins Operate
As mentioned, stablecoins are pegged on the traditional currency (the Fiat currency), such as the U.S. Dollar. The dollar, for example, is regulated by the central bank, and since it supports the stablecoin, volatility is not as high because it is linked to a centralized financial system,
There is no government intervention for cryptocurrencies that are not linked to the centralized system, such as Bitcoin, and they are bound to swing in any way, posing high risks to the investors.
This is how Stablecoins work to maintain their stability;
- Use of Fiat-backed Stablecoins– It is possible to buy stable coins using the fiat currencies such as the dollar. For instance, Coinbase sells on a 1:1 ratio of a dollar to a coin known as the USD coin(stablecoin). While other cryptos have very high fluctuations, this currency does not, and as such, one can buy and store it in the wallet for later use. However, this is not an assurance that the prices will remain stable since the currency is still new in the market, and not much of a decision can be promising for now.
- Precious metal-backed stablecoins- Precious metals such as gold have long been used to hedge against the stock market. As such, these metals help maintain the stablecoins value and help manage the volatility experienced in the crypto market.
- Crypto-backed Stablecoins- While other cryptocurrencies back the stablecoins, they are equated in such a way that the cryptocurrency used to back them up is highly rated. For instance, $1 of a stablecoin is backed up by $2 of the crypto asset. This backing up is done with anticipation of a volatility crisis, and in the event of a price surge, the stablecoin can recover the $1 that remains.
- Algorithmic stablecoins– As the name states, this is like working in a mathematics class where a computer is used to keep an eye on the crypto market. For instance, if the stablecoin is pegged at $2 Usd, but the supply falls, then the likelihood is that the price will go up. To maintain the price at an expected level, the algorithmic stablecoins release more coins in the market, and the price will decrease.
Why are Stablecoins used?
There are numerous reasons why people use stablecoins. Among these include;
- Since they withstand volatility, stablecoins offer accessibility and mobility.
- They are still decentralized, and therefore one can use them when they wish to, which possess the quick transfer of money within the expected timelines.
- They are also used for crypto staking and help users to earn rewards.
Risks that come along with Stablecoins
Despite the assurance of low volatility, these coins also have risks.
- It’s a new technology that is prone to vulnerability such that there are chances of losing the private keys and your entire portfolio.
- There is still a high level of regulatory uncertainty from the government. If consumer protection is initiated, then this could affect the coin holder when implementing the restrictions.
Where are Stablecoins Bought
If you wish to use stablecoins, then you need to sign up for a digital wallet or a crypto exchange to access them. However, ensuring that the digital wallet you sign for is available in your country is vital. Coinbase is an example of an exchange that has stablecoins. You can also use peer-to-peer to exchange the existing tokens with the stablecoin you wish to change to.
