The majority of cryptocurrencies are designed to be used as a medium of exchange rather than a store of value. The concern is that, due to their limited market cap, even common cryptocurrencies like Bitcoin are subject to large price swings. The lower the market cap of an asset, the more volatile its price would be.
For the time being, the cryptocurrency market cap is a small pond that is influenced mostly by regular buy and sell orders. So there's the US Dollar, for example. This is a significant problem because you can't enjoy the benefits of cryptocurrency, such as decentralization of capital and a “free for all” payment mechanism, without the price volatility that comes with it.
Consider how difficult it is to use Bitcoin or some other cryptocurrency for day-to-day transfers and selling as it is worth X one day and a half that the following. Consider what it's like to be the man who paid 10,000 Bitcoins for two pizzas 11 years ago. That's where Stablecoins come in handy. Simply placed, Stablecoins are an attempt to build a non-volatile cryptocurrency.
The worth of a Stablecoin is linked to a fiat currency in the real world. For example, the Tether (USDT) Stablecoin is pegged to the US Dollar and is supposed to stay that way no matter what happens. Stablecoins combines the ease of cryptocurrencies with the reliability of fiat currencies, resulting in faster payment and fewer regulatory obstacles. The most apparent use case, as with most coins, is to use them as a medium of exchange for everyday transactions.
No one considers these coins as a payment option because they aren't very common right now. As a result, the primary use of Stablecoins to date has been on Cryptocurrency Exchanges. When traders want to reduce their risk, they may use Stablecoins to exchange volatile cryptocurrencies for stable cryptocurrencies. If you invested in Bitcoin and don't want to risk the price of Bitcoin crashing against the US Dollar, for example, you can just swap your Bitcoins for USDT and have your Dollar worth. You could simply exchange your USDT back to BTC when you want to get back to holding Bitcoins. This approach is extremely common among crypto-only exchanges who, due to regulation, do not allow their users to trade Bitcoin for fiat currencies.
Another great feature of Stablecoins is the speed at which you can transfer funds between exchanges. Since crypto transactions are faster and less expensive than fiat transactions, the ability to settle quickly between exchanges makes arbitraging easier and closes the price discrepancies that are common among crypto exchanges.
A company will attempt to keep its Stablecoins pegged to a Fiat currency in a number of ways.
The first step in keeping a peg is to build confidence that the coin is worth what it is pegged to. If the public does not accept that one USDT is really worth $1, for example, people will automatically sell all of their USDTs, causing the price to plummet. The company backs its coins with some kind of asset in order to preserve this confidence. This collateral essentially proves that the corporation keeps its promise and that his coins are worth the pegged amount. In the case of Tether, each USDT is said to be backed by a real US Dollar held as collateral by Tether. The DGX coin, which is claimed to be backed by gold, is a different example of collateral. A collateralized Stablecoin that is backed by one or more cryptocurrencies is another option. Since a company's balance can be viewed on the blockchain, this type of collateral is much easier to audit.
The second method to keep a peg is to manipulate the market's coin supply, commonly known as an algorithmic peg. An algorithmic peg occurs when a company creates a set of rules, also known as a smart contract, that adjusts the amount of a Stablecoin in circulation based on the price of the coin. Consider the case of a Stablecoin that is algorithmically pegged to the US Dollar. If a large number of people start purchasing the coin, the price will rise, and the peg will be broken to avoid this. New coins are being produced. This increase in supply alleviates the demand-driven market increase and keeps the coin's value stable. If, on the other hand, a large number of individuals begin selling the coin, coins are withdrawn from the overall supply in order to maintain the one-dollar price peg. Stablecoins that are algorithmically pegged don't have any assets as collateral. The coin is managed by a smart contract that serves as a central bank. It attempts to adjust the price to the peg by altering the money supply.
Each method of pegging has advantages and disadvantages. Fiat collateralized pegs offer Stablecoin investors the best level of assurance that the coin is worth the asset it is backed by. Fiat collateralized pegs, on the other hand, have a number of significant drawbacks. For one, the asset is frozen and cannot be used for anything except the company's perspective. There's also the possibility of embezzlement or the closure of the company's bank account, all of which might jeopardize the confidence and the Stablecoin. Another problem with Fiat collateralized Stablecoins is that proving the corporation owns enough of the commodity to really back the sum of coins in circulation is difficult.
Skeptics, for example, have criticized Tether and demanded audits, saying the firm lacks sufficient collateral to back the USDT in circulation. The advantage of seeing the collateral on the blockchain of crypto collateralized tokens, on the other hand, is that the collateral is highly unpredictable. As a result, a premium is needed. In certain instances, the corporation would retain 150 percent or more of the collateral required to compensate for possible cryptocurrency price declines.
Algorithmic pegging has the advantage of not requiring the company to have any reserves on hand. Many would argue, however, that algorithmic pegging theory doesn't operate in practice because controlling the money supply isn't a guarantee that the peg will hold given the complexity of keeping a Stablecoin peg.
You may be asking why a Stablecoin is being created in the first place. What is the business plan? Well, there's a different benefit for each company; others may charge a fee for selling their coin, while some use their Stablecoin as a marketing tool to promote the company and other services it provides. Huobi, Gemini, Coinbase, and BINANCE are examples of exchanges that have developed their own Stablecoins in order to draw more customers to their trading sites and make fund transfers between exchanges easier.
Let’s review few examples of the most popular Stablecoins in use today.
USDT, also known as Tether, is a fiat-backed Stablecoin that is pegged to the US Dollar. Tether, the company that created the coin, has kept it reasonably stable since its launch in 2015.
TUSD stands for TrueUSD and is a relatively new Fiat collateralized Stablecoin that aims to address Tether's critics. Multiple trust firms hold collateral US Dollars in their bank accounts. These bank accounts are issued on a daily basis and are audited on a monthly basis.
GUSD (Gemini USD) is a currency that is exchanged on the famous Cryptocurrency Exchange Gemini, which was founded by the Winklevoss brothers, has released GUSD, a Fiat collateralized Stablecoin. GUSD is the world's first regulated Stablecoin, according to Gemini.
USDC, or US Dollar Coin, is a fiat-backed Stablecoin issued by Circle and Coinbase.
DAI is a crypto-collateralized Stablecoin developed by Maker Dao.
Conclusion
There has been a lot of criticism against the existence of Stablecoins. The most popular one has to do with the failure to keep the peg in place over time. This may be attributable to some of the factors mentioned above. Furthermore, a brief look at history shows that all pegged currencies are doomed to fail due to the high cost of maintaining them, especially when the peg is threatened. The Swiss Franc peg to the Euro in 2015, the Chinese Yuan to the US Dollar in 2005, the Thai Baht to the US Dollar in 1997, and the gold standard-pegging the US Dollar to gold in 1971 are also well-known examples of pegs being broken.
The problem of governance is the more major problem. Since there is a company behind Stablecoins that controls the peg, whether algorithmic or collateralized, many people believe them to be centralized. As a result, Stablecoins aren't really cryptocurrencies in the sense that they aren't decentralized. Another concern is that Stablecoins seems to be solving a problem that is just a temporary issue rather than a long-term issue. Once cryptocurrencies reach a larger market cap, their volatility would drop significantly, and Stablecoins will become useless.
Stablecoins are attempting to combine the advantages of both worlds. The consistency of a well-established currency with a wide demand and the decentralized “free for all” flexibility of a cryptocurrency. The dilemma is that they have the worst of all worlds: a centralized coin controlled by a kind of central bank and a questionable ability to maintain public confidence in it.
