Stablecoins have emerged to plug the gap between still-new cryptocurrencies and the traditional economic market.
For all their calming qualities, these digital assets are remarkably exciting. Why? Greater predictability means they can help integrate blockchain currencies with the conventional economy, in a genuine bridge between financial worlds.
Stability is their magic sauce. The ‘stable’ coin offers traders exactly this, a digital currency you can buy, trade and invest in a more secure environment. The best of both worlds, in fact—the flexibility of DeFi currencies and the lower risk provided by less volatile markets.
It’s not that easy, of course. In practice, stablecoins have their pros and cons. But these stabilising assets are definitely giving cryptocurrencies a leg-up in terms of next-level financial integration.
What is a stablecoin?
Stablecoins are digital assets which mimic the value of major global currencies or ‘fiat’ currencies.
Fiat money refers to government-issued currencies backed by the government issuing them, rather than any physical commodity or asset like gold or silver.
Because stablecoins shadow both the value and security of bedrock currencies like the US dollar and euro, they allow traders to further their DeFi ambitions while taking advantage of generally lower market risk. You get to play it both ways, if you like.
Volatility: the major crypto challenge
The incredible volatility of cryptocurrencies has made it hard for ordinary folk to use them in their daily lives.
Take digital currencies like Ethereum and Bitcoin, for instance.
- Still new in currency terms
- Relatively small markets
- Not value-connected to tangible assets
- Wild fluctuations day to day, am to pm.
Anyone can trade in cryptocurrency—a democratic and decentralised medium of exchange. Understandably, however, not everyone wants to embark on such a crazy ride.
Stablecoin is the calmer alternative
Stablecoins fall into three main categories.
- Fiat-backed
Also called fiat-collateralised, this is the most popular type. Directly backed by fiat currency in a ratio of one to one, the central issuer or bank reserves a set amount of fiat currency and issues the equivalent value in tokens.
Pro: User can trade and redeem freely.
Con: You must trust the issuer to reserve the right amount.
- Crypto-backed
These work the same as fiat-backed stablecoins, but the issuer backs them with cryptocurrencies rather than fiat currency.
Pro: You’re not in the hands of a single issuer.
Con: Relies on everyone in the network doing the right thing.
- Algorithmic
Token management relies on algorithms and smart contracts to control supply, demand and value.
Pro: They are managed entirely on the DeFi network.
Con: Token supply and value grow and shrink rapidly.
What’s the verdict?
What’s the future for stablecoins? On the one hand, they complement cryptocurrencies, introducing a measure of market stability. This could entice more everyday traders into the crypto network, while helping traders and investors to hedge their portfolios.
Yet fiat-backed stablecoins are not strictly decentralised, needing a central issuer to hold the supporting assets. Beyond this, traders have to trust the wider crypto community to act in good faith.
So standby for the next stablecoin chapter!
Lead Image: learnbitcoinanalysis.com
