Despite its wild fluctuations and extreme volatility, the cryptocurrency market dragged many crypto enthusiasts from rags to riches. However, the unpredictability of Bitcoin also paints a sad and sour portrait of this digital innovation. Unable to understand their exposure to risk and identify the key factors driving price swings, many investors are ending up broke. Enter stablecoins.
Like traditional fiat currencies backed by governments and pegged to an underlying asset, stablecoins are designed to protect investors from rampant volatility. In short, these are digital currencies that maintain roughly the same value from the time you buy it to the time you trade or spend it. And while the Bitcoin blockchain is used in many productive capacities, a growing number of people are looking at stablecoins to access the crypto infrastructure.
How stable are stablecoins?
To maintain stability, stablecoins are backed by a reserve asset. This means the cryptocurrency is collateralized by fiat currencies and cashed-out tokens need to be backed by assets from their reserves. As such, stablecoins offer the privacy and instant processing of the crypto ecosystem coupled with the fixed value of fiat currencies.
Some of the most popular fiat-collateralized stablecoins include Tether (USDT), USD Coin (USDC), TrueUSD (TUSD), and Binance USD (BUSD). These are all pegged to the US dollar. Stablecoins are also backed by commodity prices such as gold: Tether Gold (XAUT) and Digix Global (DGX). Some are backed by silver or even commodities like oil.
There isn’t a centralized authority such as a bank or a government standing behind these currencies, and the reserve assets are maintained by an independent financial entity. These custodians maintain and regularly audit the reserves to ensure the necessary compliance.
Another option is stablecoins collateralized by other cryptocurrencies. However, to account for their high volatility, more tokens are required to maintain a reserve, and a lower number of stablecoins is issued. For example, DAI (DAIUSD) is backed by crypto assets.
Finally, there are stablecoins that aren’t collateralized and don’t use any reserve but lean on algorithms and smart contracts that manipulate the coin supply on the market. The algorithm acts similarly to the centralized authority, as it automatically decreases or increases the number of tokens in circulation depending on price fluctuations.
What are the benefits of using stablecoins?
Stablecoins aren’t perfect, and no one can say with any degree of certainty how long these digital assets will remain competitive on the crypto market. Nevertheless, some of its characteristics are commendable, including the aforementioned blend between an anonymous payment mechanism and a stable value. Those who need a stable form of payment but don’t like depending on banks and middlemen have come to appreciate stablecoins.
The popularity of stablecoins soared in 2020 when Visa partnered with Circle to allow transactions in USDC.
Today, stablecoins have great potential for digital asset trading, as their holders can quickly convert their unpredictable crypto assets into more stable ones and thus preserve their gains. Here, it’s worth mentioning that Tether’s daily trading volume is double that of Bitcoin. This is a good investment for those looking to store money within the crypto ecosystem and use stablecoins to buy other digital currencies.
However, if you’re interested solely in quick profits, you should probably go for Bitcoin and other cryptocurrencies that have the potential to skyrocket in value. Also, keep in mind that stablecoins are prone to inflation, as they are pegged to traditional fiat currencies.
How are stablecoins going to be regulated?
In October of this year, the International Organization of Securities Commissions (IOSCO) announced plans to regulate stablecoins. At the same time, a chorus of politicians called for increased oversight of stablecoins and the regular audits of their issuers. The Biden administration is even suggesting bank-like regulations, threatening to curb the growth of this emerging sector.
With stablecoins gaining a foothold in the crypto ecosystem, powerful voices want to see the currency placed under the umbrella of securities or commodities, making it prone to government regulations. It’s becoming increasingly apparent that regulators are stepping into the crypto world in an effort to curb the fluctuating market and set rules. This might be the final chapter of unregulated crypto investments and a good time to step into the market.