What Are Stablecoins? Why Do We Need Them?

What are stablecoins? Why do we need them?

Bitcoin dropping below $39,000 put a selling pressure on the entire crypto market. With a sudden change in prices and unclear course, it is high time to hedge in stablecoins which are protected from such volatility. What are stablecoins, why are these crypto assets special and what uses do they have — an explainer for any level of crypto knowledge.

What are Stablecoins?

The so-called stablecoins are a kind of cryptocurrency that is tied to a price of another asset, usually a fiat currency and in a 1:1 ratio. Of course, they can be tied to prices of other assets, such as commodities like gold or even real estate.

What is the point of stablecoins? They combine the benefits of widely spread real-world currencies with cryptocurrencies’ usability. By opting to use a stablecoin instead of digital fiat currency, users gain access to an unstoppable network without downtimes and borders.

Types of Stablecoins

Fiat-Collateralized

The most common type of stablecoins today are fiat-collateralized stablecoins: their worth is defined by cash and asset reserves in the custody of an issuer. The entire supply of such a stablecoin is dictated by the volume of these reserves: new tokens get minted when more is added to the reserve.

The stablecoins that are used the most are pegged to the United States dollar, such as Tether USD (USDT) or TrueUSD (TUSD). However, naturally there are tokens that are pegged to other fiat currencies: XSGD (SGD-pegged, issued by Xfers), Stasis Euro (EUR-pegged), Qcash (CNY-pegged, QC), and Rupiah Token (IDRT).

Commodity-Collateralized

Another type of stablecoins that works by the same principle is commodity-collateralized stablecoins. The principal difference is in the type of assets the price of a token is pegged to.

Prime examples of this type are gold-pegged Tether Gold (XAUT) and PAX Gold. Various startups attempted to provide alternatives, such as SwissRealCoin backed by a portfolio of Swiss real estate.

Crypto-Collateralized

The third type, as the name suggests, is characterized by the reserves being in crypto assets. A characteristic feature of these stablecoins is overcollateralization, in which the ratio of collateral to the token is greater than 1:1.

Celo Dollar and Maker DAI are such stablecoins. They are issued by the protocol in exchange for providing collateral in cryptocurrencies, and the collateral reserve is entirely on-chain instead of being in the hands of one entity.

Algorithmic

Finally, the last type of stablecoins does not rely on reserves or collateral. Instead, the value of these stablecoins is maintained by algorithms that balance their supply and demand.

Some of these stablecoins are issued by Ampleforth and Terra. They use seigniorage to buy out or sell stablecoins in exchange for native AMPL and LUNA tokens, respectively.

Why and How to Use Stablecoins?

Censorship-resistant global medium of exchange

What are stablecoins used for, then? In the crypto world, stablecoins represent the real-money we are well familiar with. Therefore, they can be used as a medium of exchange.

This is not limited to purchasing goods and services, by the way. Stablecoins are most widely adopted in decentralized finance (DeFi). DeFi services double the real world financial and fintech services, and even improve on them.

DeFi and yield farming

There are already automated markets, insurance, lending, gaming and even metaverses. While many of those make use of their native cryptocurrencies, stablecoins are also a common sight.

However, since the prices of stablecoins are predictable, can you make money on stablecoins? It is actually well possible because DeFi protocols cut out on the middlemen and automate most processes with smart contracts, so the lending and borrowing protocols yield more than any traditional financial service.

Volatility and inflation hedge

Last but not least, stablecoins can be an uncensorable and unstoppable hedge against volatility in both the crypto market and against real-world inflation. This conversation is especially thriving now, when the crypto companies, including stablecoin issuers, discuss how they should approach sanctions imposed on Russia after its invasion of Ukraine.

How to Pick a Stablecoin?

So, what do you need to account for when choosing the best stablecoins for your needs?

  • Type of collateral and collateralization. If you need a more widely accepted option, you can look at USD-backed tokens but if you want to secure your savings, gold-backed stablecoins might be better;
  • Degrees of centralization. Tether Ltd., for example, issues the most popular stablecoin USDT but their integrity has been questioned. More decentralized alternatives, such as DAI, are less protected from volatility and “black swan” events;
  • Available markets. If you consider trading with stablecoins or using them in DeFi, you have to know where the stablecoin is accepted in the first place;
  • Supported blockchains and protocols. Stablecoins exist across different blockchains and second layers on top of them. The same stablecoin on a different blockchain or platform is actually a different token. Some platforms, such as Ethereum, are more widespread but have problems with high transaction fees.

You can buy USDT on our site with a Visa or MasterCard bank card for USD, EUR or RUB.

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Conclusion

So, what are stablecoins useful for these days? Hedging against volatility, inflation or even earning with DeFi lending and borrowing. The choice of issuers and networks is abundant, but ultimately this is arguably one of the most handy classes of crypto assets out there.

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