What are stablecoins?
A stablecoin is a type of cryptocurrency that provides price stability and is backed by some reserve assets, (e.g., US dollar or gold). This makes it more stable to constant market fluctuations. The idea of the stablecoin emerged in 2012 in the Mastercoin documentation. However, it came in handy only in 2015 when Tether Limited launched the very first stablecoin.
Why was it needed?
High volatility makes cryptocurrencies hard (or even impossible) to use on a daily basis. When the chance of high inflation is excluded, it is possible for the public to use stablecoins. The stablecoin has an opportunity to become a reserve currency for countries with a high rate of inflation and to provide worldwide stability. The main idea of the stablecoin is to provide the best features of the crypto world and the banking industry.
The fact that stablecoins are backed by assets makes them more attractive as an exchange medium, and that is even more important to making them attractive as a store of value. These peculiarities make it more realistic for stablecoins to become a substitute for fiat money.
What types of stablecoins are there?
Stablecoins can be divided into three categories.
- Fiat-backed stablecoins
- Crypto-collateralized stablecoins
- Non-collateralized stablecoins
Fiat-backed stablecoins
From the name of these stablecoins it becomes clear that they are backed by fiat money. More often they are tied to the US dollar. Usually the value is fixed at a 1:1 ratio.
What are the advantages of fiat-backed stablecoins?
- Stable. Unlike cryptocurrencies, which are highly volatile, fiat-backed stablecoins are tied to something that does not change value so fast.
- Easy to understand. A lot of cryptocurrencies exist in very complicated systems. At least they seem to be rather difficult for the understanding of people who are not a part of the crypto world. However, fiat-backed stablecoins are simple, and this looks attractive.
What are the disadvantages of fiat-backed stablecoins?
- Third party. While the whole crypto world is trying to avoid the necessity of having a mediator, fiat-backed stablecoins are very controlled. Otherwise, it is impossible to provide safety and the link between fiat money and stablecoins. Therefore, users have to develop trust in a third party.
- Centralization. The 1:1 ratio can be provided only if it is centralized.
- Audit. An audit is a part of a control system. It helps to provide all the special features.
- Slow withdrawal
Examples of fiat-backed stablecoins include Tether (USDT), TrueUSD (TUSD) and PetroDollar (XPD).
Crypto-collateralized stablecoins
This type of stablecoin is backed by crypto or digital currency. It is possible to maintain a 1:1 ratio with the help of over-collateralization.
What are the advantages of crypto-collateralized stablecoins?
- Decentralization. Due to the use of digital currency as a backup, it is possible to avoid centralization.
- Transparency. Everyone can monitor the blockchain, thus there is no need for auditors.
- Higher liquidity
- Faster regulation
What are the disadvantages of crypto-collateralized stablecoins?
- Lower degree of stability. In comparison with fiat-backed stablecoins, the degree of stability is lower here. The reason is that cryptocurrencies are less stable in general.
- Dependence. In this case stablecoins are tied to another cryptocurrency’s viability.
- Complexity. The system of crypto-collateralized stablecoins is more complicated for users than the system of fiat-backed ones.
Examples of crypto-collateralized stablecoins include Dai (DAI) and bitUSD (BITUSD).
