What Are Stablecoins, and Why Are They Important?

Ever since the early days of Bitcoin, one of the main goals of cryptocurrency has been to replace the traditional financial system. And while completely altering a structure that has existed for centuries has proven sufficiently challenging, there have been many efforts to merge these two spheres. That’s where stablecoin currencies come into play.

But what exactly are these, and how have they become one of the main focal points in the cryptocurrency landscape? By definition, stablecoins are cryptocurrencies that are stable in value. However, it’s only once you dig deeper that you realize the complexity and importance of stablecoins.

So, strap in and get ready to learn what stablecoins are and how they have a pivotal role in today’s diverse financial ecosystem!

What Are Stablecoins?

Stablecoins represent a blend of the stability of fiat currencies and the versatility of cryptocurrencies. They are designed for crypto enthusiasts and investors who want to participate in the market without relying on highly volatile assets such as Bitcoin, Ethereum, and other altcoins.

The way stablecoins typically maintain value is by being pegged to a traditional financial system currency, commodity, or instrument, such as gold or the US dollar. That way, they bridge the gap between fiat money and crypto coins and tokens.

Essentially, stablecoins were designed to bring the best of two worlds since they:

1. Provide the security of the blockchain and access to assets that have immense upside potential
2. Allow investors to hold a volatility-free cryptocurrency without fear of sudden and significant losses

Stablecoins are perfect for instant processing and everyday transactions, but they also act as a hedge against unexpected movements in today’s crypto market. Still, the concept of a stable and pegged currency isn’t new, as even the US dollar was pegged to gold until 1971.

The first stablecoin was released back in 2014, and it was called BitUSD. It was collateralized by other cryptocurrencies using smart contracts, and it lost its peg to the US dollar in 2018. That wasn’t the only time stablecoins lost their peg, which historically has triggered heavy criticism and raised lots of concerns.

The most recent large-scale depeg happened with the UST, which caused a $60 billion crash of both the UST and LUNA. That raised a lot of questions in the community regarding stablecoins and whether they fit in the realm of cryptocurrencies.

Still, stablecoins such as Tether’s USDT and Circle’s USDC remain some of the biggest cryptocurrencies by market cap and the most widely used tokens for trading and storing value.

The Importance of Stablecoins

Stablecoins proved to be the cornerstone of the cryptocurrency market. They offer a convenient way to transact on a global scale, even for those who aren’t crypto-savvy professionals. Moreover, their seamless integration with digital apps and systems makes them suitable for traders, enthusiasts, and long-term holders alike.

Here are some of the key benefits of stablecoins:

• Volatility hedge. Even the biggest and most stable cryptocurrency, Bitcoin, can drop in price by 80% or more. It’s not uncommon for more obscure altcoins to lose 99% of their value or disappear completely. On the flip side, stablecoins are designed to have their value pegged, preventing these fluctuations.
• Cryptocurrency gateway. Beginner investors usually have a much easier time grasping the concepts of stablecoins and using them to manage their portfolios, as opposed to dealing with more volatile coins.
• DeFi growth. Many platforms and services in the world of decentralized finance rely on stablecoins. They offer attractive lending, borrowing, and yield farming stablecoin rates, which are usually much higher than what traditional banking systems can provide.
• Security and transparency. Unlike centralized fiat currencies with centralized governing authorities, stablecoins offer transparent transactions and come with robust blockchain security features.
• Enhanced transactions. Transferring stablecoins between users is often faster and cheaper than with traditional banking systems, regardless of borders and location.
• Financial inclusion. Stablecoins are especially valuable to users in regions with limited banking infrastructure or where local currencies are particularly unstable and prone to loss of value.

How Are Stablecoins Used?

Stablecoins have many use cases—more than the vast majority of cryptocurrencies. Some of the ways you can use stablecoins include:

• Daily transactions. Many vendors accept stablecoins, just like fiat currencies. Moreover, you can use a crypto debit card to spend your assets at traditional POS terminals while effortlessly keeping track of your portfolio.
• Remittances. The flexibility of stablecoins makes them great for sending money across borders. These transactions usually take minutes, and the fees are lower than they are with wire transfers.
• Trading. Many experienced traders use stablecoin pairs, as they are the easiest to manage. Some of the most popular trading pairs include BTC/USDT, ETH/USDT, XRP/USDT, etc.
• DeFi. Stablecoins are essential for lending, borrowing, and yield farming on the DeFi platforms. They add invaluable stability to otherwise highly volatile ecosystems.
• Collateral. Many crypto platforms allow users to take out loans while depositing their stablecoins as collateral.
• Salaries. With the adoption of cryptocurrency and stablecoins, some companies have started using them to pay salaries to their employees. This method is especially popular with companies that work with freelancers or new businesses that don’t yet have bank accounts.

Types of Stablecoins

There are different types of stablecoins based on how they are backed and how they maintain their peg. Based on that, stablecoins can be split into three distinct categories, so let’s explore all of them.

#1. Fiat-Collateralized Stablecoins

Fiat-collateralized stablecoins are the most straightforward type. As the name says, they are directly pegged to the fiat currency. That peg is maintained by keeping a reserve of fiat assets equivalent to the number of minted crypto tokens.

These stablecoins are issued by third parties that mint and burn tokens while assuring the holders they can always exchange their crypto for fiat. Some of the most popular fiat-collateralized stablecoins include Tether’s USDT (also the largest stablecoin by market cap) and Circle’s USDC.

A subsection of fiat-collateralized stablecoins are commodity-backed ones. They are backed by physical assets such as gold or oil, with Paxos Gold (PAXG) and Tether Gold (XAUT) being some of the most prominent.

The main point of concern with this type is collateralization. The issuers need to be regularly audited to provide proof that their reserves match the circulating supply.

#2. Crypto-Collateralized Stablecoins

Crypto-collateralized stablecoins operate similarly to fiat-collateralized ones, except they are backed by other crypto assets. Since cryptocurrencies are susceptible to market volatility, these stablecoins maintain their peg using smart contracts.

These stablecoins are soft-pegged to fiat currencies. In essence, smart contracts automatically adjust them to maintain their value. For example, if the value of the collateral drops, smart contracts might liquidate some stablecoins to keep them stable.

One of the most popular crypto-collateralized stablecoins is the Ethereum-based DAI. The currency is managed by the Maker Protocol, created by the decentralized organization MakerDAO.

#3. Algorithmic Stablecoins

Algorithmic stablecoins (also known as seigniorage-style coins) are governed by algorithms that control their supply to maintain the peg. They aren’t backed by any fiat or crypto collateral. Instead, the algorithm increases or decreases the supply of the tokens based on demand.

The upsides of this model are that it can be completely decentralized, and there’s no need for reserves. However, algorithmic stablecoins are also the most experimental and the least stable during extreme market conditions.

They are often criticized for “creating value out of nothing.” These concerns only escalated with the stablecoin crash of UST, which is why asset-backed stablecoins remain the more popular and safer choice for medium- and long-term investing and management.

6 Popular Stablecoins

Now that you know the different types, let’s see a stablecoin list with some of the most prominent ones.

#1. DAI

DAI is an Ethereum-based, crypto-collateralized stablecoin. The token is governed by a decentralized system called MakerDAO. Since DAI isn’t backed by fiat US dollars, it maintains its peg to it by using smart contracts.

A decentralized nature and smart contract-based stabilization mechanism made DAI a popular choice in the DeFi ecosystem. Its transparency and ability to operate without a central governing authority make this stablecoin attractive to many cryptocurrency enthusiasts.

While DAI started as a single collateral version, it migrated to become a multi-collateral DAI in 2019. The previous, single-collateral version remains known as SAI.

#2. Tether

Tether, also known as USDT, is arguably the most famous stablecoin. The token was launched in 2014, and it has maintained a 1:1 peg to the US dollar with only slight variations since then.

The company behind the stablecoin claims that it’s fully backed by assets held in their reserve. However, there have been transparency concerns over the years, regardless of the many audits, scrutiny, and legal challenges regarding their collateralization claims.

Still, USDT is the largest stablecoin by market cap today and a dominant force in the crypto sphere. It’s widely used for trading on many centralized exchanges, including Binance and KuCoin.

#3. USD Coin

USD Coin, often denoted as USDC, is a fiat-backed stablecoin issued by the financial company Circle and the centralized exchange Coinbase. While it features a considerably lower market cap compared to USDT, USD Coin has gained significantly more trust in the crypto community due to its transparency and regular audits.

Similarly to USDT, USDC is used for CEX trading, albeit to a lesser extent. On the other hand, it’s a commonly used token on DeFi platforms and various dApps. Moreover, it’s a preferred choice by institutional users, not only retail investors.

#4. Binance USD

Binance USD (BUSD), as its name suggests, is issued by Binance, the world’s biggest centralized exchange. Binance partnered with Paxos, one of the global leaders in the financial and blockchain spheres, to create a US-backed stablecoin.

One of the main perks of BUSD is that it’s regulated by the New York State Department of Financial Services (NYDFS). They do regular audits, while Paxos also publishes monthly attestation reports on their websites. These attestations are also conducted by a third party in accordance with the American Institute of Certified Public Accountants (AICPA).

All that regulation, coupled with the stability of the US dollar and the trading potential capabilities of the Binance exchange, makes BUSD a popular choice for traders on the platform.

However, Paxos stopped minting new BUSD tokens and is now only redeeming the remaining ones for USD. Furthermore, Binance is steadily removing trading pairs that involve BUSD, which means holders might want to move to another stablecoin.

#5. TrueUSD

TrueUSD (TUSD) is the first 1:1 USD-pegged stablecoin with real-time audit reporting. Users can visit the cryptocurrency’s website at any moment to check and verify the results of these audits and monitor the reserves. That adds a layer of trustworthiness that differentiates TUSD from many other stablecoins.

Furthermore, the team behind TUSD does not charge fees for minting and redempting tokens. That enhances its liquidity and makes it an attractive choice for both experienced traders and entry-level enthusiasts.

TUSD supports more than 10 different blockchains, and it can be purchased and exchanged on more than 100 centralized exchanges and DeFi platforms. That versatility, coupled with reliability through transparency, makes TUSD an enticing option for safety-oriented users.

#6. USDD

USDD is a crypto-backed US dollar-pegged stablecoin issued by the TRON DAO organization. The tokens are minted and redeemed using smart contracts on the TRON network. This approach ensures fast and transparent transactions, enhancing the asset’s trustworthiness.

The stablecoin is overcollateralized by several different cryptocurrencies, including Bitcoin and Ethereum. It’s one of the most recent stablecoins on the list since it was launched.

One of the key features of USDD is that it’s governed by a decentralized community of stakeholders. They can make decisions regarding the management and development of the project, ensuring it aligns with the needs of the users.

Some of the centralized exchanges that listed USDD include KuCoin, Bybit, and Huobi, while among the decentralized exchanges there are PancakeSwap, SushiSwap, and Uniswap.

Stablecoin Risks and Drawbacks

While there are plenty of advantages to stablecoins, they aren’t without risks and drawbacks. Here are some of the key concerns and potential issues:

• Centralization. Many stablecoins rely on centralized authorities to govern their reserves, maintain the peg, mint, and burn tokens. This is especially prominent with fiat-backed stablecoins, such as USDT and USDC. Centralization goes against the main principles of cryptocurrencies. Plus, the governing bodies are susceptible to attacks.
• Transparency. While the majority of stablecoin issuers claim to have fully backed reserves, transparent audits have shown that’s not always the case. Furthermore, even auditing bodies can be influenced, which means there can be trust issues.
• Collateral volatility. Stablecoins backed by crypto can suffer if the total value of collateral drops significantly. That can result in the destabilization of the stablecoin’s value or permanent depegging.
• Regulatory risks. The more stablecoins evolve, becoming strong fiat alternatives, the more they are targeted by governments and regulatory bodies. They might impose stablecoin bills, rules, and regulations that could impact the functionality of stablecoins.
• Algorithmic uncertainty. Algorithmic stablecoins are relatively new and still in the experimental phase. While they can be a great solution in theory, practice has shown that these mechanisms can be unstable in extreme market conditions and that there’s more work to be done on perfecting these types of stablecoins.
• Redemption issues. In situations where many users decide to swap their stablecoins for fiat, they could cause problems with issues akin to bank runs in traditional finance. Withdrawals could be slowed down, and the process could even result in liquidation in cases of undercollateralization.
• Overcollateralization. Crypto-backed stablecoins need to be over-collateralized due to the volatility of cryptocurrencies. That results in more assets being locked up than necessary, which is not efficient and can have an impact on the rest of the market.

The Future of Stablecoins

At the moment, the future of stablecoins looks bright. As the world becomes more digitally oriented, mainstream adoption increases. Stablecoins might become the preferred method of daily transacting for many users.

One place where they are seeing continuous expansion is DeFi. As DeFi platforms continue to grow, so will the demand for stablecoins that facilitate borrowing, lending, yield farming, and other financial activities.

On the other hand, many traditional banks are already looking into creating their own digital currencies. However, these CBDCs (Central Bank Digital Currencies) only look like stablecoins. In reality, they are polar opposites since they are completely centralized and there’s no transparency.

Furthermore, as the popularity of stablecoins continues to increase, chances are they’ll attract more regulatory attention. However, it remains to be seen whether that will bolster or hinder their growth.

Key Takeaways

That concludes our journey through the intricate world of stablecoins. As you can see, they represent much more than just a type of cryptocurrency. Stablecoins blend the world of traditional finance with the innovation and versatility of digital assets.

This mix bridges two seemingly disparate realms into a functional unity with the promise of a secure and decentralized future. As digital transactions become more prevalent, the likelihood of mainstream adoption of stablecoins is only going to increase.

While there are many challenges ahead, the promise of stablecoins is undeniable, and they remain a big step forward!

Stablecoin FAQ

• Is stablecoin a good investment?

  Stablecoin can be a good short- to mid-term investment and a way to earn passive income during a period of downtrend in the market. Long-term holders should keep in mind that even stablecoins are susceptible to crashes and depegs.

• What is a US stable coin?

  A US stablecoin is a cryptocurrency that’s pegged to the value of the US dollar. In essence, the value of every token of said currency should remain $1, regardless of the cryptocurrency market movement.

• What are the top 5 stable coins?

  The top 5 stablecoins by current market cap are USDT, USDC, DAI, TUSD, and BUSD. They are all distinct cryptocurrencies with varying characteristics and use cases and with different issuers. As a result, it’s important to do research before investing in any of them.

• Are stablecoins safe?

  Stablecoins are considered some of the safest cryptocurrencies in terms of volatility. However, there are several concerns to be aware of, including the potential for depegging, collateralization issues, fiat crashes, and more.