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Knowledgebase What are stablecoins?

What are stablecoins?

  • Beginner
10 Aug 2022
6 m
cryptocurrencies

Intro

Most cryptocurrencies are known for their rapid price changes – their volatility is what makes them popular among traders.

The volatility is in the nature of most cryptocurrencies. Some people investing in crypto can make millions on rapidly increasing prices, while some lose a lot due to the rapid plummeting of crypto prices. This is exactly why even significant cryptocurrencies like BTC can’t be reliable enough to be accepted as a means to buy crypto coins to trade.

There is a solution, though ‒ stablecoins. Stablecoins are less volatile, which means you can use them to buy and trade other cryptocurrencies like BTC. Let’s take a closer look at them.

What are stablecoins and how do they work?

What do we call a crypto stablecoin? Stablecoin means a cryptocurrency that has a value directly tied to another, more stable asset ‒ for example, a fiat currency, a certain product, or other, more stable cryptocurrency. The point is to ensure the stability of stablecoin’s price ‒ this way, it becomes easier to buy other cryptocurrencies for trading. You can easily think of some stablecoins as a virtual analog of fiat currencies ‒ USDT will be a good example of that.

What do stablecoins do to ensure their stability? Basically, they track an asset they’re tied to. In some global projects, it works like that:

  1. A company wants to issue a stablecoin. To do that, it has to have a reserve at a bank or another institution of a certain amount of the fiat currency to back a stablecoin.
  2. Let’s say, the reserve is around $1 billion. With that in mind, the company issues 1 billion stablecoins with $1 worth each.
  3. If anyone wants to cash out this stable cryptocurrency, the assets from the fiat reserve are used to make sure there is no price fluctuation due to the purchase. And just like that, the reserve can be filled to that $1 billion again for the same reason.

A principle like that is what makes every stablecoin crypto entirely different from BTC and other famous cryptocurrencies that are known for their volatility. Basically, no speculations are possible with stablecoins as their value is tightly tied to fiat or material assets.

Sure, some stablecoins tie their prices not to material assets but rather to computing capacity. Or, as it most commonly is called, algorithms that keep up the necessary amount of the cryptocurrency. The discussion around algorithm-backed stablecoins is still open as they’re still more stable than BTC and other cryptocurrencies but less reliable than asset-backed stablecoins.

Differences from other cryptocurrencies

Differences from other cryptoc

The main difference is, of course, the stability. Being tied to some “actual” values makes stablecoins more convenient to use in online purchases. Stablecoins are easily accessible, easy to transfer, flexible, and totally transparent in their use.

Bitcoin and Ethereum are known for their price fluctuations. If you’re keeping up with the cryptocurrency market, you probably know how Bitcoin was flying high with its price reaching up to $60k and then flying down to $20k. This kind of volatility can be explained by what everyone calls the fear and greed index ‒ a balance between the will to buy a certain cryptocurrency for a low price and the fear that the price will drop.

Every stablecoin has what other cryptocurrencies don’t have:

  1. Low volatility. As we mentioned above, stablecoins reflect their name in having a constantly stable price. What it means is that there won’t be any extreme fluctuations in price even if cryptocurrencies like Bitcoin drop or raise their numbers in a day.
  2. A storage and transaction system are similar to fiat currencies. You can store stable cryptocurrencies in any crypto wallet without any fees and complete transactions all over the globe without high fees. A good solution for places where it’s difficult to do USD currency exchange or where the local currency is having a turbulent time.

Also, with stablecoins like USDT, USDC, and BUSD, you can earn interest with higher interest rates than regular banks usually offer for fiat investments. Transactions are fast and extremely cheap, and you have no limits in sending these coins worldwide.

Why do people use stablecoins in crypto trading?

Stable cryptocurrencies solve the biggest problem the crypto market has ‒ volatility. The volatility makes it risky and difficult to use crypto coins for trading. A close tie to “real” assets creates stability in the price for stablecoins, meaning they can be easily used for buying goods online. Apart from that, a stablecoin can be used as a cryptocurrency for crypto brokerage. It’s more convenient than directly using fiat currencies to purchase Bitcoin or other cryptocurrencies.

Also, stablecoins like USDT and BUSD are known for their easy use in smart contracts ‒ their stability allows them to back contracts with volatile crypto in a safer way.

Are there any risks?

With what we used as a stablecoin definition, it might seem like there’s completely no risk in using them. Sure, compared to other cryptocurrencies, the risk is little to non-existent. That doesn’t mean, though, that other risks associated with cryptocurrencies have nothing to do with stablecoins.

Risk No. 1: Security

You still need a wallet or an exchange to store your stablecoins, just like with any other cryptocurrency. Any wallet, be it hot or a cold one, always has vulnerabilities. Exchanges get compromised, wallet platforms can have security breaches, and cold wallets can sometimes be lost. This is a universal risk for every cryptocurrency, and even stablecoins are not secured against it.

Risk No. 2: Conflict of interest

Sure, stablecoins are decentralized, but this decentralization cannot be implied without a few facilities providing you with this cryptocurrency: you have to indirectly deal at least with the company issuing a stablecoin and a financial facility holding reserved assets to back the cryptocurrency. What provides stability, can also create turbulence in case the company and the financial facility get conflicted.

Risk No.3: The problem of algorithmic stablecoin

We referred to cryptocurrencies backed by algorithms earlier in this article. The main problem with stablecoins like that is their relative instability ‒ we don’t know the computing capacities for sure and if they will be enough to back the stability of the cryptocurrency. Algorithms can also return errors, but it’s a highly rare problem.

List of the most popular stablecoins

popular stablecoins

It might seem like stablecoins are seriously underrated. This is a rich statement ‒ just because stable cryptocurrencies don’t get a lot of hype on social media and in the crypto community, doesn’t mean they’re not that popular. Sure, you won’t get rich just by investing in cryptocurrencies like this, but that’s not the main purpose of stablecoins, on the other hand.

So, what are the best stablecoins for now (August 2022) are:

  1. USDT. USDT, or Tether, has a market cap of $82 billion and is widely used in trading and crypto investing.
  2. USDC. USD coin is exactly what’s in its name ‒ it’s a digital version of the US dollar, backed with a $49 billion market capitalization. These $49 billion reserves are circulating between various US financial institutions, making it nearly impossible for this stablecoin to change its price. As we said, it’s basically a digital version of the US dollar.
  3. BUSD. Binance USD is used on the Binance exchange platform to simplify the process of purchasing certain cryptocurrencies. With a market cap of $17 billion, BUSD is commonly used for transactions within the platform and investing in regular cryptocurrencies.

Market capitalization numbers of stablecoins don’t even come close to those of Bitcoin or Ethereum. But, still, considering what makes stablecoins different, it’s not a big deal.

Final thoughts

Overall, stablecoins offer you what other cryptocurrencies don’t have: price stability at nearly any time. You can use these cryptocurrencies for investing and trading ‒ but only as a means to buy other cryptocurrencies. Stablecoins are easy to transfer online, but their main problem is becoming unstable if something happens to assets they’re tied to. Considering that an actual crisis that can destabilize USDC, for example, is a really rare event in comparison to what happens with other cryptocurrencies’ prices, stablecoins are still great for storing your assets in digital form and even earning interest.

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