Crypto 101: Are Stablecoins Worth Trading?

Introduction

If you're new to the crypto space, there's quite a lot of information you could have come across, and the crypto lingo is probably throwing you overboard and off your feet. Getting used to major terminologies, their conceptual meanings, and their importance to cryptocurrency is key to your success in this space. In this piece, we will be explaining one of the critical terms in Crypto, called “Stablecoins.”

What are Stablecoins?

Just because stablecoins can be algorithmically linked to any fiat (government) currency, such as hard foreign currencies like the Yen and USD, there's a good chance that you already heard that stablecoins are digital dollars. That's not entirely accurate.

Stablecoins, in any form, exist to improve the predictability of cryptocurrency. As the name suggests, stablecoins were designed to counter crypto's inherent volatility and provide a convenient method for traders to retain their complicated currency valuation without needing to withdraw money out of the market and permit users to pay for daily products and services in digital currencies without all the budgeting drama that comes with it.

How Do Stablecoins Work?

To a large extent, all stablecoins operate in the same way. Users can buy, sell, and trade them on an exchange or other platforms, just like any other cryptocurrency. Stablecoins can be stored in hot wallets and cold storage devices just like any other cryptocurrency.

To maintain their authenticity, just about all stablecoins are connected to a contingency fund of external assets, such as a stash of fiat currency or commodities such as gold. In most cases, the stablecoin developer owns reserves equal to stable coins in circulation. In this way, any stablecoin holder can buy a dollar worth of stablecoins at any time.

Ideally, a cryptocurrency should preserve its buying value and have the lowest possible inflation so that tokens may be used rather than saved. It's possible to achieve this ideal behavior with the use of Stablecoins.

Having the money guaranteed by the complete confidence and credit of the government that issued it attracted the interest of Stablecoins developers. Fiat currencies sometimes benefit from some price stability as a result of this.

On the other hand, many fiats are seen as being under the jurisdiction of their respective central banks. Stablecoins are designed to bridge the gap between cryptocurrencies and fiat currencies. Stablecoins may be divided into three groups according to how they function.

Stablecoins with Fiat Collateral

This kind of stablecoin is built on the foundation of the US dollar, which is used as a form of collateral. Gold and silver and other commodities like oil may also serve as collateral for stablecoins; however, most of the current stablecoins rely on dollar reserves.

Independent custodians hold such reserves and are regularly audited to ensure applicable regulations. There are two major cryptocurrencies in this category, each backed by one dollar deposit: Tether (USDT/USD) and TrueUSD (TUSD/USD).

The USDT has a market valuation of about $80 billion as of March 2022, making it the third-largest cryptocurrency.

Stablecoins That Don't Need Collateral

There are stablecoins without a reserve, but they have a functional mechanism to maintain a stable price, similar to that of a central bank. In the case of the dollar-pegged stablecoin, the number of tokens may be increased or decreased by agreement.

Such activities are comparable to those taken by a central bank to keep the value of its fiat currency stable via the issuing of banknotes. Implementing a smart contract on an independent decentralized system makes it possible to do this.

Stablecoins with Cryptocurrency Collateral

On the blockchain, smart contracts are used instead of relying on a single issuer. When you buy a stablecoin of this type, you entrust your cryptocurrency to a smart contract in exchange for tokens with a fixed value. Stablecoins that use crypto-collateral as collateral are known as crypto-collateralized stablecoins.

If you want to get your original collateral back, you can return your stablecoin to the smart contract where it was initially placed. This mechanism is most prominently used by DAI, the most widely used stablecoin. MakerDAO uses a collateralized debt position (CDP) to secure assets on the blockchain as collateral.

Conclusion

Stablecoins have the potential to replace the current currency. With the extra advantage of digital assets, they can be used just like fiat currencies. You can also buy them directly on Crypto exchanges. Because of the collateralization, there is no need to be concerned about price fluctuation.

However, there are threats to their worth, including currency inflation and lack of trust. Because of the absence of generic auditing and regulation for all Stablecoins, it's impossible to tell whether the specific entity producing the stablecoin you hold will enable you to redeem the stablecoin at face value. Investors and regulators must decide whether or not to put their faith in the stablecoins’ issuing institution. Customers who buy digital currency should research and educate themselves on the hazards involved.