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A decade ago, along with the introduction of Bitcoin, people saw the rise of many alternate cryptocurrencies or altcoins within the crypto world. Today, the total number of these coins has reached 2224, as per data obtained from Coinmarketcap. However, Bitcoin and other cryptocurrencies tend to experience drastic fluctuations in their rates depending on their supply and demand. However, there is also a cryptocurrency that keeps its prices stable and unaffected by huge volatility, called stable coins. If you are wondering how that's possible then, keep reading this article to understand the basics of stable coins.
What Is a Stable Coin?
A stable coin is a relatively new category of cryptocurrencies that aims to provide price stability to its crypto coins as well as a reserve asset that supports it. Stablecoins are acquiring immense popularity due to the double benefit they offer to their users:
- Quick transactions along with robust security and privacy are similar to other cryptocurrencies.
- Consistency in price and valuations is similar to Fiat currencies.
What is the reason for their price stability?
Crypto users often get curious about how stable coins maintain their consistency and efficiently avoid volatility, while literally, every other crypto coin faces wild fluctuations in the market. To understand, we have to get a little deeper into the subject.
So, as per data, there are two types of stable coins, one is supported by the cryptocurrency and the other by national currency, and they both depend on collateral.
The collateralized stable coins are linked to a real currency, for example, the U.S. dollar. And, their issuers hold up to the real-world money to back up their crypto coin value.
On the other hand, stable coins that are backed by cryptocurrencies are connected to the price of crypto assets such as ETH. These stable coins might also link with decentralized applications, which are basically collections of collateralized crypto coins.
There are also some stable coins that make use of certain algorithms to control their own supply and demand; hence, they can equalize the circulation volume of coins to the volume of coins held in reserve.
Another question that confuses people is why stable coin users don't use the USD when it can efficiently serve the same purpose as stable coins?
This is due to the better financial services offered by stable coins compared to USD.
For example, users might face additional costs if they trade cryptos for USD.
Also, dollar withdrawals sometimes tend to make users suffer from unreasonably extended processing gaps. Another factor is the expensive fee on large and frequent USD withdrawals.
Stablecoins, with their usage in the broad spectrum of crypto transactions, is getting support from a large user base as they offer financial stability and liberty to perform as many exchanges as they want along with robust security. As no central authority governs users’ actions, they get multiple opportunities to expand their crypto reserve and make profits.
Different categories of Stablecoins
There are three categories of stable coins based on their working mechanism:
- Fiat-Collateralized Stablecoins
Fiat-collateralized stable coins retain a fiat currency reserve as collateral to put out an adequate quantity of stable crypto coins. Different types of collateral other than fiat currency may involve valuable metals like silver or gold, as well as products such as oil, yet a large portion of the current fiat-collateralized stable coins opt for dollar reserves.
Such reserves are secured by autonomous managers and are constantly audited for allegiance to the essential adherence. TrueUSD is one of the popular crypto coins that retain a worth equivalent to a U.S. dollar and is supported by dollar reserves.
- Crypto-Collateralized Stablecoins
Here, other cryptocurrencies support Crypto-collateralized stable coins. As there are chances of high volatility in the reserves, such stable coins are made to be highly collateralized— meaning, a more significant quantity of cryptocurrency tokens is conserved as deposits in contrast to the number of stable coins it wants to put out.
- Non-collateralized stable coins
These types of stable coins don't utilize any deposit system yet incorporate a functioning mechanism, similar to a central bank, to keep the price steady. This mechanism functions the same way a dollar-fixed base coin mechanism does to increase or decrease the stockpile of tokens on an on-demand basis.
Such activities resemble the working of a central bank where they print banknotes to retain fiat currency valuations. For this, ir uses a smart contract on a decentralized platform, which operates independently.
Why are people more drawn to stable coins over other cryptocurrencies?
Cryptocurrencies do not work under any administration or firm. Also, they are free from the supervision of social, political, and other financial institutions. These are the digital money that relies completely upon its supply and demand in the market; Hence, in this manner, they can be highly volatile.
This volatility results in the absence of public trust in crypto coins as a balanced and durable currency alternative. Impoverished and indistinct regulation also play a role in adding to this public doubt. Due to the absence of an organized framework to direct the proper adoption of cryptocurrencies, individuals are concerned and subsequently see it as a risky investment.
Due to the undeniable degrees of uncertainty in cryptocurrencies, investors will generally retreat to safer alternatives like Stablecoins.
How do stable coins affect the price of cryptocurrency?
Though there are thousands of crypto users on a global scale, around 20% of total bitcoins are occupied by merely 448 users. These users have the upper hand in the crypto trading world and are often called the "Whales." These entities can influence the rates of cryptocurrencies in a significant manner. Due to the increasing uncertainty of crypto coins, whenever Whales convert their crypto holdings into stable coins, automatically crypto coins rates go remarkably down. This is how stable coins indirectly affect the price of cryptocurrencies.
Conclusion
Though cryptocurrencies started the craze of digital money trading, it seems that stable coins are taking over their popularity. In January 2021, the market capital value of stable coins just crossed 100 billion U.S. dollars. However, it totally depends on the capacity of users to deal with the uncertainty that comes with cryptocurrencies; If someone has robust expertise in handling the market value fluctuations then, cryptocurrencies are the best way to earn profits; however, for others who prefer more stable environment, stable coins are the best trading solution for them.
