Stablecoins - Creating Cryptocurrencies That Are as Stable as USD

As of May 2021, the global investment in cryptocurrency was around $1.5 trillion. Many people consider crypto as a good investment with such a huge market cap, and many businesses have been embracing it as a medium of exchange. However, most cryptocurrencies are highly volatile, and while they have made many people exceedingly rich, many have equally lost their life savings in a twinkle of an eye. Let’s look at the volatility of bitcoin which accounted for over 40 percent of the total cryptocurrency.

When bitcoin first came into circulation in 2019, it was reported that an American spent two bitcoins on buying just one Pizza. On January 31, 2015, a bitcoin was sold for $216,92. In March 2019, bitcoin was worth less than $4000, but on April 16, 2021, it peaked at $62,000. But that doesn’t mean it keeps on increasing. Since then, it has fallen to less than $35,000, losing over 40 percent of its value in less than two months.

Bitcoin is not alone in this volatility risk, so are ethereum, litecoins, and many other cryptocurrencies. However, some cryptos are pegged with popular currencies or commodities to protect them from volatility. These digital currencies are called stable coins. But how stable are stable coins? Can any cryptocurrency be as stable as the US dollar? We will discuss these and many more, but let’s first look at the principle behind stable coins.

What is a Stable Coin?

A stable coin is a cryptocurrency with value tied to a government-issued currency or a popular commodity. A currency issued by the government of a country or territory is regarded as Fiat. Common examples are the US dollar, British pound, yen, yuan, and euro. Common commodities that a stable coin can be tied to include gold, diamond, or platinum. Of course, all these commodities and even the fiat currency are not absolutely stable, but they do not fluctuate in value like typical crypto. Precious metals like gold have a good chance of increasing in value over time. That will be another advantage for a stable coin that is pegged to it. Popular stable coins include Tether, Digix Gold, and USD Coin.

How Do Stable Coins Work?

?The primary aim of a stable coin is to serve as a digital currency but offer the security of stability. Stable coins have all the advantages of cryptocurrencies. They do not require a third party for the transaction. They are safe and secure and can be transferred across countries without restriction. However, they elude the major shortcoming of digital currency, which is volatility. To ensure stable coins are truly stable, they are usually secured with real money or commodities. When somebody invests in a stable coin, the equivalent amount is kept in a reserved bank. That serves as collateral. Hence when the stable coin owner decides to change their coin to cash, the equivalent amount is withdrawn from the reserve, and the coin is removed from circulation. Now, let’s look at the types of stable coins.

Types of Stable coins

Stable coins are classified according to what is used as their collateral. Therefore, we have fiat-collateralized stable coins, commodity-collateralized stable coins, crypto-collateralized stable coins, and non-collateralized stable coins.?

Fiat-collateralized stable coins:?Just as the names imply, fiat-collateralized stable coins are secured with fiat currency. Some of them are pegged to the US dollar, the euro, Mongolian tugrik, Singapore dollar, among many others.

Commodity-collateralized stable coins:?A commodity collateralized stable coin uses popular commodities as collateral for the coin. Gold is the most popular commodity in use, and owners of the coins are even allowed to exchange their coins for physical gold. Other commodities that are being used include crude oil and real estate. Some commodity-collateralized stable coins use a combination of different commodities.

Crypto-collateralized stable coins:?Despite the volatility of cryptocurrency, some stable coins still use it as collateral. However, the crypto that will be put in reserve for a stable coin will be worth way more than the value of the stable coins. This will give room for the fluctuation in the price of the reserved crypto.

Non-collateralized stable coins:?A non-collateralized stable coin does not have any form of collateral. However, it uses an algorithm to regulate the number of coins in circulation. By increasing or decreasing the supply of the coins, it tries to keep the value stable.

Uses of Stable Coins

Stable coins are created to be used for everyday transactions. They enjoy all the benefits of cryptocurrencies without the risk of volatility. Stable coins also have the advantage of not passing through a third party or government regulations. Hence, they are particularly of great benefit when used for international transactions. Commodity-collateralized stable coins can also serve as a way of investing in a commodity or real estate with low capital.

Legal Challenges

Stable coins are like other cryptocurrencies and do not require the regulation of any government. However, because they are pegged with fiat currency, and an equivalent amount is deposited in the bank; the United States?stablecoins classification and regulatory act?allows only institutions that are members of the Federal Reserve System to issue stable coins. This makes stable coins work like an alternative to US dollars. Many analysts believe this is illegal as the American constitution does not permit any individual or private organization to issue private money.

Other Likely Drawbacks of Stable Coins

Counterparty risk is another vulnerability if the reserves are held by a bank or another third party. It ultimately comes down to this: does the coin have the collateral it claims to have? Tether(USDT), for example, has been repeatedly questioned about whether it maintains a real 1-1 backing between USDT tokens and US dollars as it claims.

In the worst-case situation, a stable coin’s reserves may not be adequate to redeem all of its units, potentially causing the coin's credibility to be shattered.

Trends in Stable Coins

Despite the various interpretations of the stable coins regulatory act, over $20 billion has been invested in stable coins. 2020 witnessed about 300 percent growth from the previous year. In January 2021, Tether, the most popular stable coin, recorded a $2billion investment in just a week. The trend is expected to continue as more people develop confidence in stable coins.?

How Sustainable are Stable Coins

Many experts believe stable coins are the future of digital currency, if not money in general. With the collateral involved, there is no need to be afraid of the volatility risk commonly associated with cryptocurrencies.

Digital currencies were created to eliminate the third party in a financial transaction. Unfortunately, they soon become a speculative investment. However, stable coins eliminate the fluctuation in the value of cryptocurrencies by pegging to a fiat currency or commodity. This is achieved by depositing the equivalent amount of the coins in a bank. Stable coins are cryptocurrencies that are utilized by crypto investors who want to escape the severe volatility of other cryptocurrencies while maintaining their value inside the crypto market. With that, we can have cryptocurrencies that can be as stable as government-issued currencies.