Stablecoins: features and advantages

July 9, 2020   Tether

Stablecoins are a new generation of cryptocurrencies that are gaining popularity in the cryptocurrency world as they strive to solve the problem of cryptocurrency volatility. Let’s try to analyze all the details and nuances of this kind of virtual currency and to understand what stablecoins are, how they work, how they ensure price stability, their difference from cryptocurrencies, and their potential.

What is stablecoin


First of all, stablecoins are also cryptocurrencies, i.e. they use the same technologies as Bitcoin, Ethereum and others. However, there is a big difference caused by the need for stability: they are tied to a physical financial asset.

This asset can be gold, cash or even real estate. Regardless of which asset it is linked to, the stability of a coin can only be guaranteed by real security for that asset.

An excellent example of such collateral was the gold standard - the monetary system of the United States of America, in which the amount of money supply was strictly limited by the amount of gold in the state’s reserves.

The first dollars were even minted from real gold. The coin consisted of about 90% gold and its’ total weight was 1,673 grams. These coins were in circulation until 1933, when the gold standard was canceled.

What can stablecoins do?


Many experts of the cryptocurrency world believe that a new wave of cryptocurrency popularity will be associated with stablecoins. As you know, cryptocurrency is one of the most valued assets, which impedes the development of this tool in operational work and real business. However, the development of stablecoins can be the greatest step in the history of cryptocurrencies and in the next decade we can look at stable coins as one of the catalysts for the widespread use of cryptocurrencies, as a universal way to pay for goods and services.

As mentioned above, the distinguishing feature of stablecoin from the usual crypto from a technical point of view is the link to the underlying asset rate. We said that one of the most common methods of linking to the course is material support. This is in a simplified form. However, in fact, there are at least three common types of collateral for stablecoin.

1. Fiat provisioning. It is a type of stablecoin that undergoes a process of pegging to paper currency or real-world assets such as the US dollar, euro, yen or pound.

2. Crypto-security - providing a fixed rate at the expense of a pledge in another cryptocurrency.

An example of such stable coins are:

  • DAI, a stable coin supported by another cryptocurrency, MKR, created by MakerDAO. MKR is an Ethereum blockchain smart contract. This coin is self-reproducing and burning algorithmically depending on the fluctuations in supply and demand for DAI in relation to the US dollar, thereby ensuring the stability of this currency.
  • BitUSD (BTS) is another well-known cryptocurrency token that is provided by other Bitshares crypto assets.

3. A commodity-backed asset. Some stablecoins are provided with precious metals, such as gold, or any other metals or goods, such as, for example, oil. The most famous example of commodity security is precisely gold. There are quite a lot of similar cryptocurrency projects at the moment, but all of them are at the ICO stage or only on paper. One of the promising projects of this kind promises to be implemented by the company from the UAE “The Golden M Group”, which is going to issue the “coin M” cryptocurrency, backed by 100% gold.

In addition to asset-backed stablecoins, there is another type of stablecoin that does not have such collateral. This is a stablecoin, which is not provided with any assets, but uses algorithms to regulate demand or supply. Unsecured stablecoins do not use any reserves, but include an automatic algorithm, similar to the central bank’s rate regulation mechanism, to maintain a stable price rate. As a rule, this mechanism is sewn up in a smart contract of a coin or in the blockchain itself, the principle of which is to issue or burn a coin during fluctuations in supply and demand for it.

These actions are similar to central banks that print banknotes in order to maintain the value of fiat currency and redeem the national currency at the expense of the country's gold and silver reserves. But in our case, this mechanism works autonomously and decentralized, which eliminates the human factor and ensures stability from failures.

Some examples of such unsecured stablecoins are CarbonUSD (Carbon) and kUSD (Kowala).

The use of stablecoins in the real world


Likewise blockchain technology, stablecoins are also at an early stage of their development. Therefore, there are many opportunities for stable coins in the real world, which are listed below:

  • As an everyday currency. Stablecoins are like an ordinary currency that can be used for mainstream trading, but with the additional benefits of fixed-rate cryptocurrencies. This advantage is especially noticeable with transcontinental and international payments.
  • When optimizing P2P payments. Smart contracts automatically perform coding, which initiates an exchange between two counterparties without the presence of a third-party provider. This transaction method is traceable, irreversible, transparent, which makes them ideal for loan payments, rental payments, subscriptions and much more.
  • Affordable and fast money transfers for labor migrants, people traveling and living abroad. It becomes difficult for migrant workers to send remittances across the border, home, to their families. This is a rather slow and costly process with large fees and small limits on the amount of transfer. Stablecoins can make the process much easier for all people who are often abroad, away from their home. Migrant workers, tourists, businessmen and anyone who is abroad can safely use digital wallets to send / receive stablecoins from anywhere in the world almost instantly, with low costs and without price fluctuations.
  • Local currency failure protection. To prevent your savings from becoming worthless, stablecoins can be used. When exchanging for example euros for dollars, you lose a significant percentage on conversion. In the case of stablecoins, there is no such problem. Stablecoins can offer a simple solution for economies in crisis, allowing the user to quickly exchange local currency for a stable cryptocurrency, thereby protecting their savings from hyperinflation.

Stablecoins examples

Let's see how some of the most popular stablecoins work.


Tether (USDT)

Tether is backed by foreign currency assets. The conversion rate is 1 US dollar. A platform is considered fully secured if all assets in circulation are equal to all fiats in the bank account.

  • Benefits: Popular among cryptocurrency users. Widely distributed and integrated with many services.
  • Disadvantages: Centralized, unsafe, audit failures.

Makerdao

Maker is a decentralized autonomous organization. Its’ stablecoin is Dai, each worth $1. Stability is maintained through an autonomous smart contract system. Another brainchild of MarkerDao - DGX - stablecoin with reference to the gold rate. 1 DGX = 1 gram of gold. Provided on the same principle as Dai, due to MKR smart contract

  • Benefits: wide network of partners and payment points, availability of services with a depository and interest for storage, there is the possibility of a loan and easy conversion to other types of cryptocurrencies
  • Disadvantages: an opaque security scheme difficult to audit

Synthetix

The stability of this coin is provided due to the high collateral value. Thanks to the smart contract, you can lock in 10,000 SNX tokens to issue 1 SUSD, which is equal to 1 US dollar. If the SUSD rate starts to deviate from the fiat rate, then to unlock the locked SNX tokens of Syntetix, you must either lock up an additional amount of SNX in the ratio of 10,000 to 1, or burn the excess amount of SUSD. Thus, the system becomes self-regulating at the user level of the Synthetix system.

  • Benefits: fully decentralized system; developing fast; in addition to USD, this technology allows you to tokenize almost any security or national currency.
  • Disadvantages: the novelty of technology, and therefore barriers in the form of fears and distrust from the ordinary consumer; due to self-regulation at the user level of the smart contract, there is a delay, which allows the possibility of a spread in value with the underlying asset

Basecoin

Basecoin is a very young project that was released in late October 2019. 1 BAB is pegged to $1. This project is also built on self-regulation due to smart contracts that work on the Ethereum blockchain. The essence of self-regulation is as follows. When 1 BAB becomes cheaper than 1 USD, BAB owners will have the opportunity to buy Base bond, an analogue of an ordinary bond. This effect stimulates the demand for BAB, thereby aligning it in value with 1 USD. After the parity is restored, the owners of Base Bonds have the opportunity to exchange the contract for an additional BAB.

If 1 BAB exceeds the value of 1 USD, then the owners of Base Share, similarly to the shares from the shareholders, receive additional BAB as dividends, thereby increasing the total mass of circulating BABs in the market and thereby reducing their value.

The cherry on the cake of this self-regulatory system is the fact that both Base Share and Base Bonds are purchased only for BAB, while all the coins spent on the purchase of these assets are immediately burned under the terms of a smart contract, thus self-regulation of the amount of BAB and its value takes place.

  • Benefits: Support for renowned foundations, developers - Ivy League Association of Eight Private American Universities; the system is completely decentralized and independent of the human factor.
  • Disadvantages: protocol trust required; due to self-regulation at the level of the owner of the smart contract, there is a delay in the alignment of rates, which allows a temporary difference in rates between BAB and USD.

Differences of stablecoins from other cryptocurrencies


Both cryptocurrencies and stablecoins based on blockchain technology. However, unlike conventional cryptocurrencies, the value of which is directly related to the increase or decrease in use or trading volume, the value of stablecoin is tied to a stable asset of the real world, from commodities to currencies.

Another significant difference between cryptocurrencies and stablecoins is that any value of a stablecoin must be supported by assets that are in reserve with the issuer of a stablecoin. This means that there is a risk of centralization, since there must be a central authority responsible for the security of collateral, providing access for supervisors and auditors.

On the other hand, unsecured staiblecoin with self-regulating emission based on smart contracts appears. It would seem that they have no problem with the security of the collateral asset. These stablecoins are completely decentralized and independent of the regulator. But in this case, the price of the error, which is possible in the smart contract itself, is high. Also, the opacity and complexity of the system, the lack of control over emission and provision of moments will frighten a potential user of this kind.

The popularity of stablecoins in the modern crypto ecosystem depends on two main factors:

  • Demand for stability in the cryptocurrency market
  • Extremely high volatility in the cryptocurrency market is good for traders and speculators, as it allows you to make good money, but it is destructive for a real business, which, due to sharp jumps in the cryptocurrency rate, cannot plan budgets and conduct its activities. Stablecoins solve this problem and open the gate to the real economy in the world of cryptocurrencies. The more business projects involved in blockchain technology and cryptonomy, the greater the demand for stable assets, and therefore for stablecoins.

Venture capital inflow


Another major factor affecting the growth of stablecoins is the nature of the influx of venture money. The possibility of the emergence of new business models in the market of stable coins makes it possible to make a profit for venture businessmen and large investors.

Conclusion


A stable coin is a new class of cryptocurrencies, the rate of which is rigidly tied to the price of the underlying asset. The stablecoins are gaining momentum trying to offer the best of the crypto world - instant processing, security and privacy of payments. The adoption of new forms of money will depend on their attractiveness as a means of preserving value and means of payment.

Confidence in stablecoins should be formed privately, by ensuring the issue of coins by safe and liquid assets using a decentralized technology based on the blockchain.

The strengths of stablecoins are: their attractiveness as a means of payment with a wide coverage of business and ordinary users.

However, stablecoins have plenty of risks. Here are at least five of them:

  • The threat of loss of a security reserve for suppliers of stablecoins by banks and other guarantors of the security of the underlying asset.
  • The emergence of new monopolies
  • Problems of regulation and legalization at the level of national economies.
  • The problem of scaling in the event of sharp changes in supply and demand for stablecoin.
  • Security threat to the client’s operational activities (loss of access keys to the wallet, error in entering the recipient address, freezing of the transferred funds)

Future potential


The growing distribution of stable coins will serve as an important catalyst for popularizing the use of cryptocurrencies as the main means of everyday transactions, as well as for other applications. Such applications may include using them to trade goods and services through blockchain networks, a decentralized insurance solution, derivative contracts, financial applications such as consumer loans, and forecasting markets. Such services are impossible if the transaction currency remains volatile, which entails exchange rate risks.

Despite the novelty and dampness of stablecoin technology, this asset really holds huge potential and, like a Pandora’s box, opens the gates of the cryptocurrency World for real business, turning cryptocurrency itself from a speculative toy into a real, highly effective instrument of the modern global economy.

Author: Kate Solano for Сrypto-Rating.com
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