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What is a Stablecoin?

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Michael Caloca / ONE37pm

Cryptocurrencies are a powerful financial tool, known for their privacy, digital utility and instant processing. But they are also notoriously volatile. Stablecoins solve that problem.

Would you want to carry $20 in your wallet if it went from $17 to $25 to $18 throughout the day? When you bring $20 to a night out bowling, you are prepared to spend it. When you look to make a purchase, there is a clear expectation of how much your cash is worth before you buy anything. In the world of crypto, the market needs a currency that can offer that same stability. Stablecoins accomplish that by tying themselves to fiat currencies and other stable assets.

The main advantage of fiat currencies is their price stability, so by tying a digital coin to fiat, you can get the advantages of both crypto and fiat currency. Stablecoins can also be tied to less volatile commodities like gold.

Different types of stablecoins:

Stablecoins can be collateralized (backed) by the fiat currency they are pegged to, or they can be tied to the fiat through algorithms that buy and sell the asset to match the price. They can also be pegged to other crypto currencies that are considered stable.

Fiat-backed Stablecoins

Fiat-collateralized stablecoins maintain a cash reserve of a fiat, like the US dollar, to issue their volume of coins. Example: If I have $500 million in USD, and I issue 500,000,000 coins using my coin’s algorithm, each coin is worth $1. That coin will always be consistent with the value of US dollars because it is backed by the cash reserve.

Tether is the most popular stablecoin on the market. It is also the third largest cryptocurrency by market cap, sitting at $63 billion. Tether offers different coins tied to popular fiat currencies like USD, EUR, and CNH. Tether also has a coin tied to gold.

Crypto-backed Stablecoins

Crypto-backed stablecoins are tied to fiat currencies, but backed by other cryptocurrencies rather than the fiat they are linking their prices to. These coins accomplish this by offering a higher number of coins for a lower number of stablecoins to account for volatility. They are frequently monitored and audited to ensure stability. MakerDao’s DAI is backed by ethereum, but its price is tied to the US dollar.

Example: if I have $10,000 worth of ether, I will allocate $5,000 worth of stablecoin. That way, ether could swing up and down as high as 50%, and I will still retain the value of the stablecoin.

Algo-backed Stablecoins

These coins are not collateralized by cash or crypto reserves. Rather, they are backed by algorithms that are constantly buying and selling the chosen currency to maintain a stable value. It will increase or decrease the supply of tokens to meet that expectation.

Stablecoins as a financial tool

How can you use stablecoins to boost your finance game? If you are anticipating a market dip (like the one we saw last month), you can reallocate your portfolio into a stablecoin like Tether. Then, wait to strategically jump back into the market.

Alternatively, if you need to make a quick purchase, you can take a piece out of your portfolio and convert it to stablecoin. Converting your crypto to traditional fiat can be expensive (lots of fees), so it may be easier to keep your currency digital and find a company that accepts stablecoins as a form of currency.

This is not a widely adopted practice yet, but e-commerce has a massive opportunity to adopt this. Using blockchain tech, merchants and consumers alike can find lower transaction fees with higher efficiency.

How Stablecoins help e-commerce

In late May, the Fed announced plans to research its own Central Bank Digital Currency (CBDC). It’s a press release that was really in the works for a while. I learned about US CBDCs for a client in 2019, and I still think there were talks of it before that.

Regardless, the prospects of a US-backed CBDC means a potential transformation for e-commerce. It would significantly reduce the need to convert digital money to paper money as online shopping and contactless transactions become more commonplace.

Stablecoin projects like Terra allow users to access lower fees, instant settlements, and seamless cross-border exchanges that compete with credit cards and banks. The coolest part about projects like Terra? Their coins are easy to spend, and with time, anyone can use them. It won’t require savvy users to operate. It would be as simple as buying a credit card or downloading an app.

We may see a future where many altcoins become stable assets. Bitcoin, on the other hand, is deflationary by design (there is a limited supply) and it would be very difficult to see long-term stability.

Yet, there’s really no need for popular altcoins to reach a point of price stability when stable alternatives exist. Stablecoins are (and will be) an important piece in the crypto puzzle.  

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