Stablecoin Also known as stable digital currency or digital currency with a fixed price, it is one of the interesting innovations in the world of digital currencies. You know that the distinctive feature of these currencies is their price stability. The price of these currencies is stable in different conditions and does not fluctuate like other types of digital currencies.
In this article, we explain in simple language that What is a stablecoin? And how its price always remains the same. Then we examine the types of stable coins by providing examples. At the end, we will have a look at the uses of stable coins as well as the risks and damages that this type of asset can cause.
What is a stablecoin?
Stablecoin It is a digital currency that Price And Value It's always Fixed Is. Stablecoins use different methods to maintain price stability; But most of them are more than one Other property as support use. Tether which is the largest stablecoin in the world fiat currency dollar It is used as a backup and its price is always equal to one dollar.
Stablecoins were originally created to minimize the impact of cryptocurrency price fluctuations on transactions and to act as a bridge to mainstream financial and investment institutions; But now they are trying to make their way into decentralized finance and mainstream banking, reducing the cost of payments and reducing the pressure on them.
Read more: What is Decentralized Finance or DeFi? DeFi in plain language
Currently, dozens of stablecoins with various functional algorithms have been created on various blockchain networks, which you can see on the CoinMarketCap website. But in general, stablecoins use specific methods to maintain their stability.
A common misunderstanding about stablecoins is that they are fixed in value compared to all fiat currencies. Actually, when we talk about “stable coin” or “stable digital currency”, we should know that the concept of price stability is quite relative.
Read more: What is fiat money or currency?
For example, dollar stablecoins only have a fixed value relative to the dollar, but if the price of the dollar changes against other national currencies, the price of stablecoins will also change accordingly.
Also, asset-backed stablecoins (such as gold) or stablecoins paired with digital currencies (such as WBTC) have a value equivalent to their backing units, which does not necessarily mean a fixed dollar value.
In general, the value of stablecoins is fixed only in relation to a specific currency or asset. While the currencies or assets supporting stablecoins themselves can have a variable value compared to other units of value measurement.
Types of stable coins
Stablecoins based on how they work 5 general categories below are divided into:
- Stablecoin backed by the national currency
- An asset-backed stablecoin
- Stablecoin backed by digital currency
- Algorithmic stablecoin
- Rapid Tokens
In the following, we will examine each of these 5 types separately.
Stablecoin backed by the national currency
Fiat-backed stablecoins always have a value equivalent to their backing fiat units; In this way, in exchange for each new coin to be released to the market, one unit of fiat currency will be added to the treasury of this stable coin.
Stablecoins backed by fiat currencies such as USD, EUR and JPY are the first and simplest stablecoins that are backed by a one-to-one ratio. As long as the value of the base currency (or basket of currencies, as Libra originally proposed) remains stable, the stablecoin will maintain its value. They basically borrow their credit from the credit of the issuing fiat currency, and it is the country's central bank that protects their value.
With a market capitalization of $62.2 billion (at the time of writing), Tether (USDT) is by far the largest fiat-backed stablecoin. The price of Tether is always equal to one dollar. Other prominent stablecoins include Circle and Coinbase's USDC and Binance USDC (BUSD).
Read more: What is Tether? All about the cryptocurrency USDT
Tether claimed for a long time that it was 100% backed by US dollars; But after the New York Attorney General sued Tether, it was revealed that 26% of these Tethers were debts owed by the Bitfinx exchange to Tether (Bitfinx is Tether's sister company). Tether recently announced that around 3% of the company's cash reserves are cash.
An asset-backed stablecoin
Asset-backed stablecoins are similar to fiat-backed ones; with the difference that it keeps physical assets such as gold as a backup.
Asset-backed stablecoins replace fiat currencies with a diverse range of tangible collateral; Meanwhile, gold, which is a traditional store of value, is one of the most common collaterals.
However, there are some other asset-backed stablecoins that are backed by a basket of precious metals or even Swiss real estate. Generally, this category of stablecoins is associated with a certain amount of goods, stored in a known place, and often subject to internationally recognized audits; A topic that Teter avoided for a long time.
A well-known example of an asset-backed stablecoin is Tether Gold (XAUT), launched by Tether. Each unit of Tether Gold is equal to one ounce of London gold.
Other examples of asset-backed stablecoins include Pax Gold and Digix Gold.
PaxGold is an ERC20 token created by Charles Cascarilla, CEO of Paxos. This token is backed by one troy ounce of pure London gold. This amount of gold is stored in the Brink warehouse in the capital of England, which is approved by the London Bullion Market Association (LMBA). Pax Gold holders can trade their tokens at any time and receive real gold in exchange.
Read more: What is ERC20? All about the Ethereum ERC-20 token and standard
Digix Gold is equivalent to one gram of 99.99% pure gold stored in Singapore and audited once every three months.
Stablecoin backed by digital currency
Cryptocurrency-backed stablecoins use over-collateralized loans to stabilize their value.
Cryptocurrency-based stablecoins are backed by a basket of one or more cryptocurrencies. Because the digital currencies themselves are so volatile, these stablecoins offer loans with huge excess collateral, requiring borrowers to lock their tokens in smart contracts. If the value of the collateral decreases too much, the collateral tokens are liquidated to prevent further losses.
One of the most famous stablecoins backed by digital currency is DAI, which has a value of one dollar and belongs to a platform called MakerDAO.
Die is a stablecoin Decentralized and there is no need to trust any third party to use it. Unlike other stable cryptocurrencies, whose price is fixed by backing fiat deposited in a bank, Dai's price is fixed by staking a digital currency like Ethereum in a smart contract called an “escrow fund”.
To generate Dai, the user must deposit his digital currency in a “Vault”. This fund was formerly called “Collateralized Debt Position” or “CDP” for short. At first, only ether was used for collateral in this fund; But currently, some other digital currencies such as BAT can also be used for collateral.
Algorithmic stablecoin
Algorithmic stablecoins, as their name suggests, use algorithms and smart contracts to protect price stability. These stablecoins keep their price level constant with the policy of increasing or decreasing supply (when needed) and using market forces.
With this definition, digital currency-backed stablecoins, such as DAI, which use an excess collateral system to maintain their value, are also considered algorithmic stablecoins. But in this article, for a more detailed classification of stablecoins, we have considered these cases in a separate category.
What distinguishes algorithmic stablecoins from other types of stablecoins is that they are unbacked. In fact, algorithmic stablecoins are the most complex type of stablecoins whose value is controlled by special algorithms and smart contracts. These algorithms automatically increase or decrease the supply of the token in the market to keep the price of the token equal to the fiat currency it is intended for.
If the value of these stablecoins starts to fall against the dollar, euro or any other currency, the algorithms will remove the tokens from circulation. Also, if the value of the stablecoin goes higher than the fiat currency, the system will release new stablecoins to the market to keep the price of stablecoins stable by balancing the supply and demand.
Rapid Tokens
A wrapped token is a digital currency backed by another digital currency. Many experts do not consider this type of digital currency as a stable coin because it does not have wide applications and is not very independent.
The term Rapid means “cover” and from this name you can imagine a token that is covered by another token or coin. In other words, the units of a digital currency are poured into a special address, and in exchange for it, a rapid token is automatically created in another network.
One of the prominent examples of the Wrapped token is Wrapped Bitcoin, which was first released on the Ethereum network. Each RapidBitcoin token is backed by one Bitcoin unit and thus the price of each unit is equal to one Bitcoin unit.
Since the Bitcoin and Ethereum networks are independent and Bitcoin cannot be directly used in Ethereum transactions and decentralized applications, Rapid Bitcoin Token will help people who want to operate with Bitcoin on the Ethereum network.
Among the types of stablecoins we listed, the first two categories (i.e. stablecoins backed by fiat and assets) are centralized stablecoins; Because they are controlled and managed by one or more centralized organizations, and the next three categories (i.e. stablecoins backed by digital currency, algorithmic stablecoins, and rapid tokens) are decentralized or semi-centralized, because they work using a decentralized blockchain network like Ethereum. And intermediaries have the least possible role in this.
Applications of stable coins
Stablecoins made their way into the crypto world as soon as they appeared, and their popularity is undeniable. some of The most important applications of stablecoins which we can mention are:
- everyday use
- Protecting capital against the fall in the value of the national currency
- International payments and remittances
- Facilitating peer-to-peer payments and smart contracts
- Improving the performance of digital currency exchanges
everyday use
Stablecoins can be used in everyday transactions like common fiat currencies. With the difference that stablecoins also benefit from the advantages of digital currencies.
In the near future, we may be able to pay for dinner at a restaurant using our mobile phone and pay with digital currency, just like what cryptocurrency fans dream of.
Protecting capital against the fall in the value of the national currency
In case of a sharp drop in the value of the national currency in a country, citizens can protect their property value by converting the national currency to a digital currency. But considering that digital currencies have high volatility, the best option to maintain stability is to buy stable coins.
International payments and remittances
Stablecoins can be easily used for cross-border payments and remittances; Without the need to convert digital currencies to each other regularly and spend a significant part of the amount as fees.
This idea can help many startups and companies in international shopping. Also, millions of migrant workers and their families around the world can transfer their money in the shortest time and at the lowest cost.
Improving the performance of digital currency exchanges
Currently, due to strict regulations, a limited number of digital currency exchanges support fiat currencies. The use of stable digital currency helps exchanges to solve this problem and provide users with the possibility of using crypto-fiat currency pairs, which will make the work much easier for novice traders and investors.
Facilitating peer-to-peer payments and smart contracts
The future world is full of smart contracts that perform today's traditional services such as banking, insurance, lending, renting, and salary payments automatically without the need for third-party approval. In such a situation, stablecoins will play an important role in peer-to-peer and smart payments due to their stability of value.
Risks and limitations of stablecoins
Despite all the advantages we have listed for stablecoins, these digital currencies also contain limitations and risks due to their special nature and widespread use. Some of the most obvious limitations of stablecoins include:
Centralization in a decentralized world
Stablecoins backed by fiat currencies and assets (which happen to be the most popular type of stablecoins right now) are still far from expected values in the blockchain world. These currencies are controlled and supplied by centralized institutions. Therefore, all the value of stablecoins depends on our trust in these institutions. The only available solution to solve the problem of trust in these institutions is their audit by a third party, which in turn contradicts the essence of decentralization and elimination of intermediaries.
Unforeseen problems in protocols
Some algorithmic stablecoins experience unforeseen problems in the market. Such events are caused by the fact that these stablecoins are designed only according to normal market conditions and emotions.
For example, the stablecoin Fei (FEI), which was supposed to keep its price close to one dollar without dollar backing (like Tether) and without digital currency backing (like Dai) and only through the liquidity pool of the Fe/Ether currency pair, in At the beginning of his career, he fell to half a dollar.
Low liquidity against assets
This problem is specific to stablecoins that are backed by assets. Suppose you have a coin backed by gold and you want to cash it. It will probably take you a few months to do this. You may need to travel to the country where the escrow fund is located, and for this you will have to bear a lot of expenses.
Strict laws
Stablecoins can be legally controversial depending on how they are used and who uses them. While bankers and legislative officials cite stablecoins as a very useful tool, the capacity of some tokens to compete with national currencies has made lawmakers very cautious and concerned.
For example, it is enough to take a look at the history of Facebook's stablecoin project (former name Libra and current name Dim) to understand the difficulties and obstacles facing a stablecoin with 2.3 billion potential users.
Frequently asked questions
It is not logical to introduce an option as the best stablecoin in the world, and this depends on many factors; But Tether is the first and largest stablecoin in the world.
Stablecoins have many uses. Among the most important of them, we can mention trade and preservation of capital value and international payments without the usual problems.
Stablecoins use different methods to maintain price stability, but most of them use another asset as a backing and attach their value to its value.
Conclusion
In this article, we tried to have a short and at the same time comprehensive overview of stablecoins and their types. As you read in this article, stablecoins are digital currencies that do not have some inherent features of digital currencies.
Stablecoins do not suffer from price fluctuations, and their semi-centralized nature makes them somewhat distant from the true essence of digital currencies; But the advantages of their existence in the world of digital currencies cannot be denied. These stable currencies have brought some of the security and confidence that existed in the world of fiat currencies (due to their price stability) to the world of digital currencies.
Among all types of stablecoins, algorithmic stablecoins are the only decentralized type that work without any support and only rely on their own algorithms. However, the popularity of these stable coins is still not as much as centralized types such as Tether, but with the passage of time and the increase in their popularity among people in the society, the problem of being centralized can be solved and stable coins can be used that, while maintaining price stability, They also observe decentralization.
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