Stablecoins are a type of cryptocurrency pegged to the price of an external asset, most commonly a fiat currency such as the US dollar or gold. This lowers their volatility, unlike other crypto such as Bitcoin, and offers more consistent stability with the benefits of digital assets. This blog takes a look at the different kinds of stablecoins, their key characteristics, and the impact - both positive and negative - that stablecoins can have on our financial landscape.
Stablecoins’ key characteristics
Stablecoins are pegged 1:1 with another asset. That might be a stable fiat currency such as the US dollar, or a physical asset such as gold. There are three types of stablecoins:
Crypto-backed. Crypto-backed stablecoins are backed by crypto held as collateral, but due to the volatile nature of crypto, they require over-collateralization to ensure stability.
Algorithmic. These use software algorithms to adjust the supply of a stablecoin based on demand automatically. Unlike other kinds of stablecoins, algorithmic stablecoins are under-collateralized, meaning that their value doesn’t rely on a reserve of assets.
Fiat-backed and commodity-backed. These are the most commonly used and known stablecoin, which are pegged to an asset like fiat currency (fiat-backed) or to a physical commodity such as gold or oil (commodity-backed). Fiat-backed stablecoins are most often used for trading, remittances, and lending and borrowing. They are the most popular because issuers maintain a reserve of liquid assets to back their stablecoin on the blockchain. Their liquidity and resilience against price manipulation make them highly attractive in the crypto space.
Stablecoin uses and impact on the crypto market
Trading and exchange
Stablecoins are often used as ‘trading pairs’ on crypto exchanges. Trading pairs are a combination of two cryptos that you can trade between each other. They provide a stable value against which other cryptos can be traded, without having to convert to fiat currencies. Stablecoins can also function as a hedge against market volatility. During periods of volatility, traders can convert their crypto to stablecoins, pegged and less prone to fluctuations, and protect their value.
Payments and remittances
Stablecoins offer faster and cost-effective cross-border payments, reducing third-party fees and the need for intermediaries. Businesses looking to make cross-border payments can also mitigate the impact of currency volatility and exchange rate fluctuations by using appropriate stablecoins.
Savings
Stablecoins are often used as a store of value. During market downturns, it’s possible to convert from another crypto coin to stablecoin and ‘park’ the value of the digital asset as a stablecoin until things improve. Because of this, some platforms are beginning to offer interest-earning possibilities for stablecoin holdings, allowing for passive income generation.
Risks and rewards
Stablecoins provide stability in the volatile crypto world. When pegged to fiat currencies which are historically stable, such as the US dollar, they can be perfect for everyday transactions, as a store of value, and to facilitate remittances. Stablecoins can be easily integrated with the DeFi ecosystem, providing a medium of exchange for DeFi applications such as lending and borrowing.
Another interesting positive of the stablecoin market is its possibilities for financial inclusion. Where fiat currencies experience difficult volatility, stablecoins can be a digital asset to offer citizens stability and accessible digital currency.
However, due to the uses that we listed above, stablecoins can have a significant negative impact on the crypto market if it goes wrong. They can play a critical role in providing liquidity, offering an option in times of market stability, and as a facilitator of transactions. This means that the failure of a major stablecoin could have a wide-reaching impact throughout the wider crypto landscape. Instability in stablecoin would have a knock-on effect on crypto’s liquidity and trading activities.
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