In today’s post, you will learn what a stablecoin is, and how it works.
Stablecoins are very vital to traders because it helps them protect their crypto assets from dropping in value.
In this post, you will not only learn what stablecoins are but also the similarities and differences between them.
Before we proceed, I am most delighted to tell you that we (NigeriaBitcoinCommunity.com) have been featured in the top 100 bitcoin blogs on Feebspot.
Let’s go!
Post Summary
To walk you swiftly through this post, here is what I will be discussing:
- What Are Stablecoins?
- Types Of Stablecoins
- List Of Stablecoins
- Real-World Applications Of Stablecoins
- Limitations Of Stablecoins
- Conclusion
1. What Are Stablecoins?
A stablecoin is a cryptocurrency that is pegged to an asset with a stable value, such as gold or fiat money like the US dollar.
In other words, “stablecoin” is an attempt to create cryptocurrencies that are not volatile (i.e changes in value consistently).
A stablecoin usually has a fixed value to its underlying asset.
For example, Tether (USDT) is backed by US dollars and has a stable value of $1 for each USDT token.
A stablecoin should always remain stable in its value despite the crazy volatility of other cryptocurrencies.
2. Types of Stablecoins
Stablecoins are generally divided into 4 main types or categories:
- Fiat-Backed Stablecoins
- Commodity-Backed Stablecoins
- Crypto-Backed Stablecoins
- Seignorage-Style Stablecoins
Let’s take them one after the other.
a. Fiat-Backed
The most common type of stablecoins is collateralized or backed by fiat.
‘Fiat’ is the paper money in your wallet and the digital money in your bank account.
Examples of fiat money include NGN, USD, EUR, GBP, CHF, and JPY.
Fiat-backed stablecoins are backed at a 1:1 ratio, meaning that $1 of a stablecoin is equivalent to $1 of fiat money.
So for each stablecoin that exists in this category, there is real fiat currency being held in a bank account to back it up.
Here are examples of fiat-backed stablecoins:
i. Tether (USDT)
A well-known or most popular fiat-backed stablecoin is the currency Tether (USDT).
Tether is backed by the US dollar, Euro (EU), and the Japanese yen (JP).
Its market capitalization is about $4B at the time of writing (August 2019).
Tether is issued by a company called Tether Limited.
It was launched as RealCoin in July 2014 and was rebranded as Tether on 20 November 2014.
Tether is also the 3rd biggest coin in terms of daily trading volume.
Tether is designed to offer stability (like fiat currencies), transparency, and lower transaction charges to users.
Read our complete review of Tether here
ii. True USD (TUSD)
TrueUSD (TUSD), is a popular stablecoin that was introduced in early 2018.
It was designed to be simple, transparent, and reliable.
For this reason, it does not use a hidden bank account.
It is also backed to the US dollar at a 1:1 ratio, which means 1 TUSD represents 1 $.
TrueUSD was created as an alternative to Tether because there was a controversy on the transparency of Tether being totally back by fiat.
TrueUSD is the first major project built on the TrustToken platform (TrustToken is a platform for creating asset-backed tokens).
TUSD was first traded on Bittrex but has expanded into other exchanges which include Binance, CoinTiger, Upbit, and more.
b. Commodity-Backed
A commodity-backed stablecoin is a digital currency whose value is determined by a real tangible asset.
These assets may include gold and other precious metals.
This type of stablecoins is backed by commodities (Valued exchangeable goods or materials).
These commodities may increase in value over time. And this increase gives more rewards to people who hold and use them.
Commodity holders can redeem and take possession of their assets but it will take days to do so.
An example of commodity-backed stablecoins is:
PAX Gold (PAXG)
PAX Gold (PAXG) is a digital token that is backed by real gold.
1 PAXG is equivalent to 31.1g of a 400 oz London Good Delivery gold bar.
Paxos Trust Company holds the physical gold in custody.
Also, it is stored in Brink’s vaults.
Furthermore, PAXG is an ERC-20 token and thus, secured by the Ethereum blockchain.
It is available on the following exchanges: Binance, FTX, Kraken, Uniswap, HitBTC, Crypto.com, CEX.IO, etc.
c. Crypto-Backed
This type of stablecoins is backed by other cryptocurrencies such as BTC and ETH.
In this case, the use of central depositories such as banks is avoided.
This allows for decentralization (having no central authority) since everything is done on the blockchain.
Here is an example of crypto-backed stablecoins:
Dai (DAI)
Dai (formerly Sai) is a digital currency that has its value pegged to the United States Dollar.
Because it is pegged to a fiat currency, its value does not fluctuate like that of Bitcoin and other cryptocurrencies.
It is a stablecoin implemented as an ERC20 token on the Ethereum blockchain.
Unlike other centralized stablecoins, Dai is not backed by the USD in the bank.
Rather, it is backed by the collateral on the MakerDAO platform. This collateral can be viewed on the Ethereum blockchain.
Read this detailed review of DAI to learn more.
d. Seignorage-Style
Seignorage is the only category of stablecoins that is not backed by any asset.
Seignorage coins operate with an algorithmic (accurate step-by-step) governed approach, just like a central bank that prints more bills.
As the total demand for this coin increases, new supplies are made. This is to reduce the price back to stable levels.
A fine example of a seignorage-style coin is Basis.
Basis
This coin was formerly known as ‘Basecoin’.
Basiscoin is a cryptocurrency whose value is backed by the US dollar through algorithmic adjustments of the coin’s supply.
Price stability is achieved through the monitoring of various exchange rates.
If a Basis coin is trading above $1, new stablecoins are created and distributed.
On the other hand, if it is trading for less than $1, Base bonds are created and sold.
3. List of Stablecoins
a. Tether (USDT)
This is the most popular stablecoin in terms of volume in USD as of the time of writing (August 2019).
b. TrueUSD (TUSD)
c. Paxos Standard Token (PAX)
d. USD Coin (USDC)
e. StableUSD (USDS)
I will only explain PAX, USDC, and USDS since I have already talked about Tether (USDT), and TrueUSD (TUSD) earlier.
Paxos Standard Token (PAX)
Paxos standard token is a fiat-backed stablecoin whose value is backed to the US dollar in a 1:1 proportion.
PAX is a cryptocurrency that is regulated and approved by the New York State Department of Financial Services.
Also, it is an ERC20 standard-based token developed by Paxos Trust Company.
PAX tokens can be received and sent by users of an Ethereum wallet.
Additionally, it is available 24/7 to ensure payments or exchange of any type of asset.
USD Coin (USDC)
USD Coin is a fiat-backed stablecoin that is backed by the US dollar.
This coin is the product of an open-source technology called CENTER.
USD Coin is an ERC20 token built on the Ethereum blockchain.
It allows people to use US dollars without requiring a bank account or specific geography.
This coin is regulated, transparent, and verifiable.
StableUSD (USDS)
StableUSD (USDS) is a fiat-backed or collateralized stablecoin created by Stably.
Each StableUSD token is transparent, legally backed, and redeemable for a US Dollar.
StableUSD tokens are held in an insured escrow account managed by a trusting custodian, such as Prime Trust.
By making StableUSD redeemable and pegged 1:1 with US dollars, we can eliminate volatility.
4. Real-World Applications Of Stablecoins
Stablecoins despite being in their early stage, have many potential real-world applications. Here are just a few:
i. A Day-To-Day Currency
These coins are used like any other currency for day-to-day purposes. For instance, we can use stablecoins to transfer funds, make a payment, buy pizza, and so on.
ii. Enables Reccuring P2P Payments
Stablecoins also allow the use of smart contracts for p2p (peer-to-peer) payments. In carrying this out, no third party is needed.
This is beneficial for businesses that have employees all over the world because it reduces fees and long processes.
iii. Protection From Local Currency Crashes
Because local currencies like NGN and VEF reduce in value, citizens like you and I could exchange our money for Euro or US dollar to retain their purchasing value.
Likewise, we can convert our fiat currency to commodity-backed stablecoins like gold due to its high stability in value. This protects our life savings from further drops in value.
iv. Affordable Remittances
Many people move to other countries in search of work. These people have families to support back at home.
So sending remittances (transferring money from country to country) overseas is much easier and affordable with stablecoins.
5. Limitations Of Stablecoins
While these coins present many advantages, they also have their limitations.
- Fiat-backed stablecoins are centralized, so trust is required.
- For commodity-backed stablecoins, traveling to the host country is expensive, and could take months to redeem your physical gold.
- Crypto-collateralized stablecoins are backed by cryptocurrencies. Since cryptocurrencies usually fluctuate in value this becomes a problem.
- The base system of Seignorage-style stablecoin is complex and difficult to understand.
Conclusion
In this guide, we have finally come to know:
- what a stablecoin is,
- the 4 different types,
- how it is applicable in our daily lives,
- its limitations and so on.
Now, I’d love to hear from you:
Which stablecoin will you like to try out first?
Did I leave out any important information in this post?
Please, drop your answers in the comments section. Feel free to ask related questions too.
Stablecoins are the best thing that have happened to the crypto community so far. The volatility of the market can be avoided now without having to withdraw the investment entirely from the platform.