Since cryptocurrencies are traded freely without third-party administration, the main concern around adoption is volatility. Stablecoins bring a middle ground between traditional and decentralized finance since they are tied to fiat currencies like the US dollar, Euro, British pound, etc. These stablecoins make it possible to take advantage of the potential benefits from cryptocurrencies while still giving users control over their money; they do this by providing an intermediary in case the value of the cryptocurrency falls below the value of the fiat currency with which it’s pegged.
What Are Stablecoins?
Stablecoins are cryptocurrencies pegged to fiat currencies like USD or EUR so they are not volatile. They are essentially cryptocurrencies that offer collateral, which makes them ideal for exchanges that don’t offer fiat trading pairs. This means traders can exchange them for traditional government-backed currency and hold it safely in their bank accounts while having access to all of the benefits of cryptocurrency.
Why Are Stablecoins Necessary?
Stablecoins are necessary because cryptocurrencies are not sufficiently stable on their own. The volatility of crypto makes it more challenging for investors to spend them on everyday purchases and trust in their purchasing value. To maintain worth, crypto should have the lowest inflation rate possible so that it retains value over a long period of time. In order to build a bridge between the perceived stability of Traditional Finance (TradFi) and Decentralized Finance (DeFi), businesses need a more reliable medium of exchange. That’s where stablecoins come in.
Types of Stablecoins
Fiat-backed
These are centralized coins backed by reserves of foreign currency in designated bank accounts. The reserves can also be commodities like oil or precious metals like gold or silver. Central banks around the world are pursuing blockchain technology as a tool to streamline payments processing. Some examples are TrueUSD (TUSD) and Tether (USDT).
Crypto-backed
These coins are backed by other cryptocurrencies which makes them more volatile than Fiat-backed stablecoins. The issuer holds a large number of tokens as a reserve and releases a lower number of stablecoins to avoid volatility. One example is DAI.
Algorithm-backed
These coins are backed by an algorithm designed to issue more coins when the price increases and buy them to take them out of the market when the price dives. Clear examples are TerraUSD (UST) and Ampleforth (AMPL).
Final Thoughts
Stablecoins are a hot topic these days, with countless conversations about them taking place in various online communities, especially on Telegram. Many governments are finding a connection with crypto through stablecoin adoption, even if they’re still wary of initial coin offerings (ICOs). If you look at Tether, you can see that it is being used as a stable store of value or unit of account. Even though stablecoins create a wide variety of new opportunities by generating liquidity in the crypto world, they shouldn’t be used as cash since they are still new to the market.
