Ask CryptoVantage: What’s the Point of Stablecoins?

What Are Stablecoins?

Stablecoins are cryptocurrencies that attempt to offer price stability in response to the inherent volatility experienced by most cryptos.

This is done by pegging the value of the coin to something more stable, such as fiat currencies like the USD or to a commodity’s price such as gold. They are then collateralized by having a backing of assets held in reserve, for example if a company issues $1 million USD stablecoins then they should theoretically also hold $1 million USD in reserve.

Types of Stablecoins

Generally, there are three types of stablecoins: fiat-backed, crypto backed, and commodity-backed.

A fiat-backed stablecoin is something like Tether (USDT), or TrueUSD (TUSD), or USD Coin (USDC). These stablecoins are backed by reserves of fiat in the form of the USD. There are other stablecoins pegged to different currencies such as the Euro or British Pound, the only difference being they are backed by reserves in that currency. In theory all fiat-backed stablecoins should be redeemable for the actual fiat currency whenever you wish.

A crypto-backed stablecoin is something like Multi-collateral Dai (DAI). These stablecoins are issued with cryptocurrencies used as collateral. Due to the inherent volatility of using an unstable asset as collateral, you often need to hold a much greater reserve than you would compared to a fiat-backed where you simply pay an equivalent amount in fiat and receive the stablecoin.

Commodity-backed stablecoins are backed or collateralized by commodities such as gold or silver, which are much less likely to experience inflation the way fiat-backed stablecoins can. This is due to the inability to create more gold and silver in contrast to the ability to print more money. Commodity-backed stablecoins should theoretically be redeemable for the real asset, meaning the company who issues the coin needs to maintain, store, and protect the commodity to ensure equivalent reserves for potential redemption of all coins issued.

What is the Point of Stablecoins?

A great use for stablecoins is to hedge against volatility and in a way, short digital assets. Since the value of the stablecoin experiences little fluctuation, a crypto holder can mitigate their losses during a bear market by turning their unstable cryptos into stablecoins and wait out the market. In addition, if they feel the value of a cryptocurrency they hold is going to drop, they can convert it all into stablecoins and then buy back the asset at a cheaper price.

Another use for stablecoins is for payments across borders, if you would like to send someone USD who lives in another country, the fees for sending stablecoins are generally far lower than if you were to send a fiat money transfer. In addition, stablecoins are sent nearly instantaneously. The ability to do this is extremely useful for those in countries where it is difficult to send or receive money without being charged exorbitant amounts in fees and conversions.

Finally, stablecoins can be used to pay people within the cryptocurrency ecosystem. If you are paying developers in the asset they are working with, it can lead to dumping of the asset when they need to pay their bills, or a loss in value overnight due to the volatile nature of non-stablecoin assets, which would essentially mean they have been underpaid. By paying people in stablecoins you can provide stability to both the asset they are helping to develop, and to employee’s financial situation.