BlogJul, 2021

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Stablecoins – A Hit or a Miss?

Stablecoins have been around for approximately seven years. Still, the debate over them has never been as hot as it has been in recent weeks, not only among crypto enthusiasts but also among regulators and traditional investors.

The price volatility of cryptocurrencies has given them a bad image. Bitcoin's price, for example, soared from less than $5,000 in the first quarter of 2020 to over $30,000 in the fourth quarter, owing to exceptional institutional demand.

While this is a good indicator for adoption and speculation, the volatility of cryptocurrencies like Bitcoin and Ethereum has hindered them from becoming a common form of payment. Nobody wants to pay for a cup of coffee with a risky asset.

Stablecoins, on the other hand, are less volatile than other cryptocurrencies since they are pegged to other assets such as the US dollar.

What is Stablecoin?

Stablecoins are a sort of cryptocurrency whose value is frequently tied to various assets, including government-issued currencies like the US dollar, precious metals like gold, and even other cryptocurrencies.

Issuers have been experimenting with various techniques for realizing and maintaining the price peg of stablecoins to the underlying assets. USDT (0 percent), USDC (+0.01 percent), BUSD, and GUSD are examples of stable coins backed by reserves whose dollar worth is expected to equal the circulating supply tokens. Others, such as tether gold, representing one troy fine ounce of gold on a London Good Delivery bar, are backed by tangible goods.

There are also algorithm-powered decentralized stablecoins like DAI (+0.03 percent) and FEI.

How do Stablecoins work, and where are they used?

Fiat currency (conventional currencies like the US dollars in your bank account), other cryptocurrencies, precious metals, and algorithmic functions are all used to back stablecoins. However, the source of a cryptocurrency's backing might have an impact on its risk level: For example, a fiat-backed stablecoin may be more stable since it is linked to a centralized financial system with a central authority figure (such as a central bank) that may intervene and control prices when valuations are turbulent. 

Because there is no regulating agency monitoring what the stablecoin is anchored to, stablecoins that aren't linked to centralized financial institutions, such as a bitcoin-backed stablecoin, may fluctuate dramatically and quickly.

Most people traded cryptocurrency against government ("fiat") currencies and other cryptocurrencies before stablecoins became popular. "Spot trading versus stablecoins began to dominate a larger share of trade activity starting in 2017," according to Pankaj Balani, CEO of crypto derivatives exchange Delta Exchange.

Crypto lending also makes use of stablecoins. Depositing USDC in a savings account with Coinbase, one of the firms behind the stablecoin will earn you a 4% yearly interest rate. The interest rate on USDT deposits might be anywhere from 1.66 percent and 13.5 percent.

Types of Stablecoins

  • Fiat-backed Stablecoin: 

Described as an IOU – you buy stablecoins with your dollars (or any fiat money) and then redeem them for your original currency later.

  • Crypto-backed Stablecoin: 

Other crypto assets back them. Crypto-backed stablecoins are overcollateralized to safeguard the stablecoin's value because the backing asset can be volatile.

  • Precious Metal-Backed Stablecoin: 

These use gold and other precious metals to preserve their value. These stablecoins are centralized, which may be seen as a disadvantage by some in the crypto community, but it also protects them against crypto volatility.

  • Algorithm-backed Stablecoin: 

These coins aren't backed by anything, making them the most challenging stablecoin to comprehend. To avoid the coin's value from fluctuating too much, these stablecoins use a computer algorithm. If an algorithmic stablecoin's price is pegged to $1, but the price rises, the algorithm will automatically issue more tokens into the supply to bring the price down. If the price goes below $1, the pool will be reduced to raise the price.

What has already happened on the stable coin front?

Recent business activity has created a lot of buzz in the industry. Visa and Circle, the blockchain unicorn behind USDC, a stablecoin pegged to the US dollar, announced cooperation in December 2020. Circle's corporate cardholders will be able to spend USDC anywhere Visa is accepted due to the relationship. "Stablecoins like USDC represent a promising payments innovation and provide an emerging platform for fintech and digital wallets to enable new payment flows," said Cuy Sheffield, Visa's head of crypto.

What is the future for Stablecoins? 

Some investors are concerned about worst-case scenarios, such as what may happen if stablecoin issuers face enormous redemption requests because of the systemic role stablecoins play in crypto trading and lending.

The danger could also spread to traditional marketplaces. Stablecoin concerns are possibly "contagious," according to a report released earlier this month by credit rating firm Fitch. According to Fitch, Tether's commercial paper (CP) holdings were $20.3 billion as of March 31, suggesting that its CP holdings may be more significant than most prime money market funds in the United States, Europe, the Middle East, and Africa.

Payments incumbents like Visa may save money on international transfers and data processing by using stablecoins. Similarly, institutions that digital adversaries threaten might use stablecoins and blockchain technology to digitize their back offices quickly.

It will be essential to keep an eye on merchant adoption. Merchants can already take stablecoins and other cryptocurrencies as payment for goods and services using crypto platforms like Bitpay and Coinbase Commerce.

Decentralized finance (Defi) applications such as loan issuance can benefit from stablecoins. MakerDao, for example, uses its native stablecoin DAI to make collateralized loans. This is an area where you may expect more incredible innovation.

That said, one of the most intriguing news stories and headlines related to blockchain and crypto is that crypto's initial promise may finally be realized. Crypto applications and use cases proceed to evolve, develop, and improve in ways that would have been unperceivable even a few years ago. Stablecoins, as evidenced by Visa's recent trial program, appears to be the future of crypto implementation, and it is a promising future.

Closing thoughts

It's easy to forget, but bitcoin's original goal was to build a decentralized and distributed payment system, which has yet to materialize. Instead, in the shape of stablecoins, an alternate (some would say better) version of crypto has developed as a monument to the free market process. Cryptocurrencies must be liquid, have low price volatility, and be connected with established financial institutions to function well as a currency alternative., and develop in ways that would have been hard to imagine,