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What is a Stablecoin And How Does it Work

Articles
02.05.2024
7min.
309
stablecoins

If cryptocurrencies were amusement park rides, Bitcoin would be that insane roller coaster that adrenaline junkies line up for. But what if you're not an adrenaline junkie? What if you want fun without fear? Enter the merry-go-round of the crypto world: stablecoins! Grab your tickets as we take you for a spin on what stablecoin is, how it manages to maintain stability, and which stablecoin is safest.

What is a stablecoin

Imagine a cryptocurrency that doesn't make you sweat every time the market decides to do the cha-cha. Stablecoins are digital currencies whose value is pegged or tied to that of another currency or commodity (most often, to the USD). They aim to provide an alternative to the high volatility of Bitcoin, Ethereum, and most other cryptocurrencies. This sounds great, but not everything is that simple, and they also have their own pitfalls. Later in this article, we will take a look at how stablecoins work and how stable they really are.

How do stablecoins work

So, how do these crypto-chameleons manage to stay calm while the rest of the market is going in a rollercoaster? It's all about maintaining that peg. Depending on the types of stablecoin, they use different methods like holding reserves, smart contracts, or algorithms to ensure they keep their value stable relative to a peg.

Types of stablecoins

Now, let's break down the types:

  1. Fiat-Collateralized. These stablecoins have a direct one-to-one peg with fiat currencies like the US Dollar. Think of them as your regular dollars but in digital form. Tether (USDT) and USD Coin (USDC) are some hotshots here. Most popular stablecoins are fiat-collateralized.
  2. Crypto-Collateralized. Instead of being backed by fiat, they are backed by other cryptocurrencies. They use smart contracts to make sure their value doesn't go on a roller coaster ride. Of course, in order not to fall along with the market of the cryptocurrencies with which they are backed, such coins, need to be over-collateralized. DAI is a classic stablecoin example.
  3. Commodity-Collateralized. These ones are hooked to the value of real-world assets like gold or oil. Ever wanted to own gold without actually having to store it? Digix Gold (DGX) has got your back.
  4. Non-Collateralized (Algorithmic). What is algorithmic stablecoin? It is a coin that is not backed by any collateral. Instead, they use complex algorithms to keep their value stable. They are always adjusting supply and demand automatically.

Which Stablecoin is the best

Safety is a big deal, especially in the Wild West of crypto. When it comes to this type of assets, the "safest" can be subjective.

Of course, there isn't a one-size-fits-all answer to “what is the safest stablecoin”. The best one for you depends on what you need it for. Tether (USDT) is widely used and has the largest market cap, while USD Coin (USDC) is known for its transparency. USDT has never experienced big drawdowns since 2017, and stablecoin USDC has proved that it can cope with them. DAI is popular among those who prefer a decentralized option. Crypto advisors recommend holding all three to meet up with diversification. And if you're into commodities, also consider Digix Gold (DGX) or Tether Gold (XAUT).

Some also consider BUSD. It used to be a popular token, but the issuer stopped supporting it. All existing BUSD tokens will remain backed and redeemable only till February 2024, Paxos said.

*As always, DYOR to find out what is the best stablecoin for you!

Why are stablecoins so important

Remember the Great Crypto Crash of 2018? Or, if you're new to crypto, perhaps you remember the bearish market of 2022? Both of them were not fun. What is stablecoin, then? And what is the point of a stablecoin? These coins are like a safe harbor in a storm for traders. When things get too wild, they can park their assets in stablecoins without moving back to traditional currency. They offer a stable value (hence the name), which is great for folks who want to avoid heartburn but still need to stay in crypto.

What can you do with stablecoins

Okay, so now you know what these assets are. But what is the benefit of a stablecoin? It's not just digital collectibles. You can:

  • Trade crypto. You can use these assets to trade other cryptocurrencies. When you feel the market might take a tumble, you can quickly switch your assets into stablecoins.
  • Send and receive money. Want to send money overseas without paying crazy fees? They will help you. If you've got an online business, accepting stablecoins could be a smoother ride for you and your customers with crypto payment gateways such as Whitepay.
  • Earn interest. Some DeFi platforms, including WhiteSwap, let you earn interest on your stablecoins using staking or liquidity mining. It's like a savings account but in the crypto world.
  • Pay for stuff. Yes, you can actually buy things with stablecoins, especially if the merchant is crypto-friendly. For example, USDT can be used to pay as easily as BTC.

They are like the bridge between traditional currencies and cryptocurrencies. They allow for faster, cheaper, and smoother transactions.

History of stablecoins

Alright, history class time — don't worry, there won't be a quiz.

Stablecoins are not as old as fiat currencies, but they've got some history.

The first stablecoin was born in 2014 and was named BitUSD. But today, this coin is not used anymore, and few people have heard of it. But instead, there are many others.

Fast-forward a bit, and you have a plethora of these assets flooding into the market, each with its own twist. USDT, USDC, and DAI are the most popular but not the only coins in the long stablecoin list. As of June 2023, the market cap of all these assets combined was over $128 billion.

By now, stablecoins became a fundamental part of the cryptocurrency ecosystem. They facilitated not just trading but were used in remittances, payments, and as a store of value in countries with unstable local currencies. Some central banks and governments don't like it, and the issuers face regulation challenges from time to time. The most recent was in 2023, when the American SEC came into conflict with the issuers of many altcoins, including stablecoins. However, to date, no legal restrictions apply to this type of assets in most countries, including the US and countries of the EU.

Advantages of stablecoins

Let's look at why people love them:

  • Stability. They provide a safe haven during the wild crypto storms.
  • Low fees. Sending money across borders with minimal fees? Yes, please!
  • Speed. Transactions are very fast compared to international bank transfers (especially when it comes to large amounts).
  • Accessibility. You don't need a bank account to own stablecoins.

Disadvantages of stablecoins

Okay, let's not sugarcoat it. There are some drawbacks:

  • Centralization. Some of them are managed by central entities, which goes against the crypto philosophy of decentralization.
  • Regulatory uncertainty. Governments are still figuring out how to deal with stablecoins, which can be unsettling.
  • Collateral risks. If the collateral takes a hit, so can the stablecoin's value.

It is these shortcomings that sometimes lead to the fact that stablecoins cease to be stable. Some assets, such as Terra Classic USD (USTC), were considered safe, but the stablecoin price has dropped below $1. Others, such as USD Coin (USDC), lost their peg for a while but managed to restore it. Nevertheless, stablecoins are still the safest and most stable assets in the cryptocurrency market.

What is the purpose of a stablecoin

You may think of stablecoins as digital versions of traditional currencies, but they are so much more than that. Their stability makes them an essential tool for traders looking to avoid the high volatility of other cryptocurrencies. By converting assets into stablecoins during market dips, traders can preserve their value without needing to exit the cryptocurrency ecosystem entirely.

Moreover, stablecoins facilitate global transactions without the drawbacks of traditional banking systems. With stablecoins, you can send money across the world at a fraction of the time and cost it would take through a bank. This makes it an ideal solution not only for personal remittances, but also for businesses engaged in international trade.

What is the future of stablecoins

The adoption of them has been increasing rapidly. They're not just for crypto traders anymore — they're starting to be used in everyday transactions. As more people become aware of the benefits, it's likely that stable cryptocurrencies will play a significant role in the future of finance.

But it's not just about shopping and sending money to your pal overseas. We're talking about how countries are now looking at stablecoins and thinking, “Why not create a digital version of our currency?”. So, don't be surprised if, in the future, your digital wallet contains some government-issued stablecoins known as Central Bank Digital Currencies (CBDCs). The United Kingdom and China are already working on it, and much more countries have such plans. As of June 2023, 11 countries already have a Central Bank Digital Currency (CBDC), and 18 more have launched a pilot version. Development status and details for each country can be found on the Central Bank Digital Currency Tracker by Atlantic Council.

However, not all governments like it. The United States, for example, treat it as a threat. So, the role of stablecoins in the global economy remains ambiguous. This discussion is ongoing, and much will depend on the decisions that are being made right now.

How to buy stablecoins

Alright, now you know what stablecoin is. So, how do you actually get these digital treasures?

First, you need a place to store your stablecoins, which is called a crypto wallet. There are many wallets out there, some are physical (hardware wallets), and some are digital (software or “hot” wallets). The most popular options are MetaMask and Trust Wallet, so you may use one of them to create your crypto wallet (if you don't have any yet).

Next, you need to find a platform to buy them. This is where crypto exchanges come in. There are two types: centralized exchanges (CEX) and decentralized exchanges (DEX). Centralized exchanges are more popular, but they are less safe and transparent. Decentralized exchanges, on the other hand, allow you to trade crypto with low fees without intermediaries. Experienced users first buy cryptocurrency with fiat money on CEX or P2P, then transfer it to their crypto wallet, and then trade crypto safely on DEX.

WhiteSwap is a DEX that allows you to trade stablecoins in a decentralized way, which means you have full control over your assets. WhiteSwap is secure and user-friendly, and they don't charge an arm and a leg in fees.

Trade stablecoins on WhiteSwap: USDT, USDC, DAI.

Conclusion

Stablecoin's stable price offers stability in a world that's often anything but. They've got a myriad of uses — from trading and hedging against market volatility, to making international transactions without the fuss of traditional banking.

But remember that there is nothing 100% stable in the financial world, and even stablecoins have their own risks. Be smart, do your research, and don't put all your eggs in one basket. May your trades be savvy and your transactions smooth!

WhiteSwap Your DEX. Your Rules.

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