One of the most significant use cases for cryptocurrency and blockchain technology is developing a payment system for the entire world. This system would be decentralized, transparent, fast, and of course, use crypto as its primary means of exchange.
However, the value of cryptocurrencies — like Bitcoin — tends to fluctuate significantly on a regular basis. The intent of crypto is to provide a more secure means of performing transactions, but the value of a specific digital currency is primarily driven by speculation.
Enter stablecoins. Stablecoins have stable prices, as their value is tied to another asset, such as the U.S. Dollar. But there is much more to know about stablecoins and how they're used in the crypto market.
So, without further ado, let’s take a closer look at stablecoins, what they are, and how they work in the crypto market.
The fiat currency you use — such as USD — maintains a reasonably reliable value on a day-to-day basis. Sure, the cost of goods and services will change a little bit over the long term, but the loaf of bread you buy today isn't going to be $5 more tomorrow.
Stablecoins aim to mimic the reliability and stability of traditional currencies in the form of digital assets. These altcoins are digital currencies that are collateralized by the value of an underlying asset. Of course, the underlying asset will vary from coin to coin, but we'll touch more on that in a bit.
For now, just know that they're typically tied at a 1:1 ratio to specific fiat currencies like the U.S. dollar or the euro. Other stablecoins might be pegged to precious metals like gold or silver, while others are tied to particular cryptocurrencies.
So why should we use stablecoins? The biggest advantage stablecoins have over other crypto assets is in their name. They're not as prone to the drastic ups and downs associated with other cryptocurrencies. They are stable. We're all familiar with the Bitcoin (BTC) pizza incident. In 2010, a programmer paid for a $30 pizza with 10,000 BTC. Today, that same amount of Bitcoin is worth almost $100 million. That's quite a price change, even if it does span a decade.
It's this type of drastic price volatility that makes businesses skeptical about using cryptocurrencies. A coin worth a few cents today could be worth tens of thousands the next. To offset this type of volatility, stablecoins were created. These coins offer the same benefits cryptocurrencies offer — transparency, privacy, low fees, and security — while providing the trust and price stability associated with fiat currencies.
Initially, stablecoins were a safety net in the event of a market crash. If the price of Ethereum (ETH) started to drop, an investor could simply move their funds into a stablecoin to avoid significant losses. However, stablecoins have come into their own, offering a wide variety of use cases in emerging markets and applications.
Stablecoins have plenty of real-world use cases. Here are a few ways they are making an impact.
01-Improving Crypto Experiences
A big challenge in the crypto market is adoption. It can be a challenge for a newcomer to learn how to convert fiat to crypto, especially if the digital asset they want isn't on a major platform like Coinbase or Binance. Since many exchanges don't accept fiat currencies, stablecoins give novice users an easier way to acquire crypto.
02-Making Remittances Affordable
There are many workers in first-world countries who regularly send funds back to their families in developing nations. Unfortunately, these remittances often have to go through a third party like Western Union. This is a slow and expensive process. With stablecoins, a user can send funds quickly and easily through a digital wallet. The fees are low, and price volatility is minimal.
03-Creating Efficient Payment Methods
Making payments can be a pain. Employees have to wait every two weeks to receive a paycheck when they may need the money immediately. International payments take days or weeks to process and complete, and they’re usually expensive.
With stablecoins, a lot of the hassle can be eliminated. A smart contract can be set up to make payments automatically. This would be ideal for markets like payroll, loan payments, or monthly subscriptions. Stablecoins would help reduce fees associated with these types of transactions while offering faster transfers. Instead of waiting three days for your funds to deposit, they would be available almost instantly through the use of stablecoins.
The vast majority of stablecoins are going to fall into one of the four following categories.
Fiat-collateralized stablecoins are the most common type you'll find. These coins are backed by fiat currencies such as USD, GBP, or EUR. These digital assets are backed at a ratio of 1:1. That means one stablecoin is equal to one unit of its corresponding currency. USDT, USDC, GUSD, and PAX are popular stablecoins that fall under the fiat-collateralized category as they are tied to the U.S. dollar.
The biggest advantage of the fiat-collateralized stablecoin is its stability. As long as the economy of the fiat currency backing the stablecoin is reliable, the value of the digital asset does not fluctuate. Even if the price of Bitcoin or Ethereum should plummet to nothing, the price of the stablecoin will remain consistent with its fiat counterpart.
A commodity-collateralized stablecoin is backed by an interchangeable asset. Many of these types of stablecoins are pegged to the price of precious metals like gold or silver. However, there are also digital assets that are backed by real estate and oil. Commodity-collateralized coins are popular because they are backed by a real, tangible asset that offers real value.
One of the more popular commodity-collateralized stablecoins is Digix Gold (DGX). This ERC-20 digital currency is backed by gold, where 1 DGX is equal to 1 gram. Other popular commodity-collateralized coins include Swiss Real Coin (SRC), a real estate coin, and Tiberius Coin (TRX), a coin backed by a combination of precious metals.
A crypto-collateralized coin is backed by another cryptocurrency. These types of stablecoins are usually overcollateralized to better manage price fluctuations.
The most well-known crypto-collateralized stablecoin is DAI, created by MakerDAO. Some argue that since Dai is pegged to the price of the U.S. dollar, it's a fiat-collateralized coin. However, it's backed by ETH, USDC, and many other crypto assets, which means other cryptos collateralize it.
The last type of stablecoin is a non-collateralized coin, also called algorithmic coins. These coins aren't backed by anything. While this might seem absurd, remember that many fiat currencies no longer use anything to back their value. They simply have value because everyone agrees that it does.
Non-collateralized coins are governed by an algorithm that controls their supply. When demand for the coin increases, new coins are automatically created to bring the price down. If there is too much supply, extra coins are purchased to bring the market price back up. An example of a non-collateralized digital asset is UST, which is an algorithmic USD stablecoin issued by Terra Money.
Some traders and investors don't often associate stablecoins with decentralized finance. The truth is, the two make an excellent pair. This is largely due to the reliability that stablecoins have to offer, which is a driving factor as DeFi has risen to prominence.
For example, through DeFi platforms, investors are able to realize 10-12% returns on their stablecoins. This contrasts with the minimal returns earned through traditional finance, which typically fall in the 0-1% range.
Additionally, stablecoins play a significant role in liquidity pools, which are integral to decentralized exchanges and the DeFi ecosystem as a whole. A liquidity pool is a pool of tokens that aids in creating liquidity for a pairing. Most liquidity pools use stablecoins as they create better liquidity for the pair since the risk of volatility is reduced.
You'll also discover that investors and traders like to use stablecoins for yield farming. Yield farming is lending or staking digital assets to create high returns that come in the form of additional crypto. For those that prefer the stability associated with stablecoins, yield farming is an excellent way to get great returns on their investment.
Simply put, you are providing the capital and earning a return on it. The challenge with yield farming is the risk associated with more volatile coins. Using stablecoins doesn't generate as much of a return, but the likelihood that the coin will suddenly collapse is much lower.
Even though not everyone in the crypto industry is sold on stablecoins, it remains one of the best options in the cryptocurrency market to bring mainstream adoption. There is no singularly perfect stablecoin; they all have their advantages and disadvantages. However, the reliability and stability they offer provide both individuals and businesses an easy way to get started in the world of cryptocurrencies.
If you're a more experienced crypto investor or trader, plenty of decentralized platforms and apps offer ways to generate revenue from stablecoins. For example, Unagii offers yield farming through its Vault app, including Dai, Tether, and USD coin stablecoins. It's a great way to put your stablecoins to work for you.