Cryptocurrencies have become one of the major players in the global economy. They are used as a means of exchange and investment options. Various merchants are accepting Bitcoin and other cryptos as payment methods while countries like El Salvador have accepted Bitcoin as a national currency. However, cryptocurrencies struggle with volatility. Given the decentralised nature of blockchain technology, cryptos depend on the market supply and demand for value.
That is where stablecoins come in. Here is all to know about stablecoins.
What are stablecoins?
Stablecoins are cryptocurrencies designed to have the price stability of underlying assets like fiat currencies while having the security, speed and low-cost transactions of the digital currencies. In the earlier crypto days, this was to manage the volatile nature of the cryptos. However, as cryptos become more vibrant, stablecoins can be used for mainstream banking and other financial institutions to access blockchain financial services.
Stablecoins work such that they are pegged to other stable assets like precious metals, fiat currencies and real estate to avoid the volatile crypto movements.
How does stablecoin remain stable?
Stablecoins draw their stability from their underlying assets. Therefore, a stablecoin is only as stable as the underlying asset. Still, these assets are also not 100% stable. They do fluctuate in value, though at slow and less disruptive rates. For example, fiat currencies tend to decline given the various political and economic policies. It is what informs inflation.
At the same time, stablecoins can vary from their underlying assets due to the trading volume. For example, in 2018 while Tether remained relatively stable to the USD, BitUSD deviated by up to 2.8% of the USD following the changing supply. That is to say, stablecoins are not as stable as expected.
However, compared to decentralised cryptocurrencies they are much more stable. For example, at the end of Q1 in 2020, Bitcoin was trading at $4,000, by the end of Q2 2021, it was valued at $65,000. These are massive changes. At the same time, Tether has only moved the same as the dollar, which was less than 2%.
Other than those backed by fiat as collateral some cryptos gain their stability from specialised algorithms and smart contracts. The smart contract monitors the supply of the tokens to demand. For example, the system reduces the supply in case of value decline. In case of a value increase, the algorithm introduces more tokens in supply. The balanced demand and supply ensure stable cryptocurrencies.
Are stablecoins the future of cryptocurrencies?
By having the stability of fiat currencies with the fast and safe transactions of cryptos it can seem that stablecoin is the future of money. However, so far most cryptos have failed to gain market traction. This is mostly due to a lack of trust from the users.
For any financial tool to work, it must inspire trust from users, stablecoins are yet to do that. For example, there were claims Tether has no underlying USD.
The tokens have also received opposition from national currencies. For example, Facebook has had to postpone the launch of its stablecoin. Therefore, for now, cryptocurrencies like Bitcoin and Ethereum remain supreme compared to other stablecoins.
