Stablecoins: Your Comprehensive Guide
Stablecoins are among the latest inventions in the crypto world. They make it easier and safer to transact, which is why they attract new investors daily. If you are here, you probably heard crypto fans praising stablecoins and got curious about what they really are. Well, you came to the right place. Today’s post will explain what stablecoins are and everything else crucial about them.
Let’s dive in, shall we?
What Are Stablecoins?
Stablecoins are cryptocurrencies backed by different assets to help provide price stability in the crypto market. They try to provide the benefits of both fiat currency and crypto. Therefore, you can enjoy the fast and secure payments cryptocurrencies offer, and the volatility-free environment fiat currencies provide.
Types of Stablecoins
There are different types of stablecoins, and they all use varying mechanisms to operate. The difference is mostly the backing asset, as that’s what determines a stablecoin’s overall stability.
Here are the three types of stablecoins:
Fiat Backed Stablecoins
As the name suggests, fiat backed stablecoins are backed by fiat currencies like the U.S dollar. Central banks stabilize the fiat currencies backing these stablecoins. Therefore, there aren’t usually much price fluctuations to affect the coin’s stability. So, their value usually matches that of their backing fiat currency. For instance, one Tether (USDT) is equal to one U.S dollar.
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These stablecoins are backed by volatile cryptocurrencies. So, they are usually prone to high crypto volatility. This causes them to be overcollateralized to reduce the chances of ruining stability. Therefore, if the stablecoin’s supply is $500, then the collateralized assets should be at least $1000. That way, even if the market becomes volatile, the coin maintains its value. Dai is a good example of such stablecoins.
Since crypto-backed stablecoins are usually less stable than fiat backed coins, you need to often check on the underlying asset’s performance. These stablecoins also require more audits than fiat backed stablecoins to ensure consistent stability.
Algorithmic stablecoins are the only stablecoins that are not backed by any digital asset. However, they have a set mechanism that uses smart contracts to prevent price fluctuations. Therefore, if the stablecoin is pegged to the U.S dollar, but its price increases randomly, the algorithm automatically supplies more tokens to help lower the price. However, if the stablecoin’s price falls, the algorithm reduces the circulating supply to boost prices. AMPL is a great algorithmic stablecoin you can check out.
Precious Metal-backed Stablecoins
This type is usually backed by precious metals such as gold. They are less volatile than crypto backed stablecoins, making them a safe alternative when you want to avoid huge volatility. Tether gold (XAUT) is a good example of a precious metal-backed stablecoin.
Stablecoins Vs. Other Cryptocurrencies
Most people think that stablecoins work like other cryptos, which is incorrect. So, this section will help you understand the difference between stablecoins and other cryptocurrencies.
Bitcoin is among the most volatile cryptos, meaning its prices fluctuate frequently. If you have been watching it lately, then you know that it rose dramatically during the pandemic before dropping by the same magnitude. So, the prices of Bitcoin and other volatile cryptos are quite unpredictable.
The market volatility discourages many people from investing in crypto, especially those who want to use it for online transactions. The volatility also makes it hard to use crypto to store value because your asset can gain or lose value in hours.
This is where stablecoins come in. Unlike most cryptocurrencies, stablecoins maintain the same value most of the time. For instance, if you have a cryptocurrency backed by the U.S dollar, such as Tether (USDT), you know today’s value will probably be the same even after a month. So, you don’t have to worry about crypto volatility.
How Do Stablecoins Work?
A stablecoin’s backing asset determines its risk level. Fiat-backed stablecoins are usually more stable because they are linked to centralized financial systems such as the central bank. Therefore, the backing currency does not fluctuate easily, ensuring stability. Crypto-backed stablecoins, on the other hand, are likely to experience some instability due to the volatile underlying crypto asset.
You can hold stablecoins in a crypto wallet like you would in a bank account. Buying and selling stablecoins is pretty seamless, and all transactions are usually recorded on the blockchain.
Stablecoin transactions are also faster and cheaper than traditional wire transfers. Therefore, you can use them to easily withdraw assets from volatile crypto markets without using fiat currencies.
What Can You Do with Stablecoins?
Stablecoins are receiving more financial inclusion daily, meaning you can now use them in different ways. Below are the most common ones:
Use for Online Transactions
Stablecoins boast more stability, making them excellent for performing online transactions. Since most businesses are starting to accept crypto, you can now use stablecoins to complete some daily transactions. Plus, stablecoins offer the same advantages as most cryptocurrencies, hence guaranteeing faster transactions, anonymity, and security.
You can also hold stablecoins in your crypto exchange wallet or cold storage as your savings. This makes it easier and more efficient to save even for huge projects without involving financial institutions, such as banks.
Stablecoins have also opened many doors to investing easily and securely. Some of the best investments you can make with stablecoins include:
Some crypto platforms allow you to lend digital assets to borrowers for an agreed period to earn interest. Unlike lending volatile coins, stablecoin lending enables you to make predictable interest payments. Therefore, if you are looking for a simple way to earn passive income that doesn’t involve technical stuff, then this is for you. Also, borrowers usually provide enough collateral for the loans, so you don’t have to worry about losing money.
Still curious? Click here to read all you need to know about stablecoin lending.
You could also stake stablecoins to support transaction verification in a blockchain and earn interest. This usually needs you to commit crypto assets for a certain period, making it a suitable option for long-time crypto investors. There are also many coins you can stake, thus providing options to choose from based on their earning potential.
Why Are Stablecoin Lending and Borrowing Rates So High
Stablecoin lending can be quite rewarding as it offers high-interest rates. However, borrowing stablecoins, on the other hand, is quite expensive since you must pay high rates to access loans. So, why is this the case?
Crypto lending platforms offer high-interest rates to coin holders to lure them to invest their stablecoins. That way, the platforms can get enough stablecoins to satisfy the huge borrowing demand. And since the lending platform also wants to earn some income, they will charge high rates for the loans.
Still curious? Click here to make better borrowing decisions and pick the best loan for your specific purpose.
Are Stablecoins Safe, and Should You Consider Them?
Stablecoins are considerably safer than other cryptocurrencies since you don’t have to constantly worry about losing your assets. They are a significantly better fit for newbies in the crypto market. However, if you are an experienced crypto trader who makes money from price changes, stablecoins might not be for you.
Still curious? Click here to help you decide whether stablecoins are a safe option.
Where Can I Buy Stablecoins?
You can buy stablecoins from any trustworthy crypto exchange. However, crypto exchanges usually offer different stablecoins. Therefore, always confirm before signing up to ensure the platform has the coins you want to invest in or save. Nexo, Binance, and Coinbase are some of the best crypto platforms to buy stablecoins. There are many other exchanges in the crypto market. So, you could explore different options to help find the best one for you.
Also, note that some crypto platforms don’t provide their services everywhere. Therefore, ensure to check if a crypto platform offers its services or the stablecoin you want in your location.
With stablecoins gaining more popularity, many people are starting to use them in online transactions more than fiat currency. This has attracted lots of attention from regulators. The International Organization of Securities Commissions (IOSCO) recently said that stablecoins with a high chance of causing a huge impact on the financial system should be regulated.
The European Union also proposed a law to make crypto investors provide their names, dates of birth, and account numbers when making crypto transactions to ensure full traceability.
Still curious? Click here to check out a detailed guide about regulating stablecoins.
Best Stablecoins by Market Capitalization
Below are some of the best stablecoins to invest in based on their stability, security, and market cap:
- Tether (USDT)
- USD Coin (USDC)
- Binance USD (BUSD)
- TerraUSD (UST)
- Dai (DAI)
You can also check out other stablecoins listed according to their market value.
Pros and Cons of Stablecoins
Advantages of Stablecoins
- They are stable, enabling you to avoid price fluctuations.
- They ensure anonymity while providing fast and secure transactions.
- Stablecoins are easier to adopt for newbie crypto traders.
- They involve fewer trading fees, making them cheaper to transact with.
- They are also pretty easy to convert from fiat currency.
Disadvantages of Stablecoins
- Stablecoins don’t provide high returns like other crypto assets.
- They require external audits to ensure accountability and stability.
- They face regulations, making their future somehow uncertain.
Stablecoins are undoubtedly huge in the crypto world and have made it easier for most people to invest in crypto. They hold great and unique features, which will likely attract even more crypto investors in the future. Fortunately, you have learned how stablecoins work. So, you can now make more informed financial decisions on how to use them.