What are stablecoins?

Beginner
March 29, 2023
Read time:
4m

Traditional cryptocurrencies offer numerous possibilities for investors, but their volatility makes them impractical for daily use. Prices constantly fluctuate, creating a significant problem as people expect their assets to remain stable over time.


Stablecoins
are cryptocurrencies pegged to other assets like the US dollar or gold, designed to reduce price volatility and increase customer trust. Essentially, if you purchase a given amount of stablecoins pegged to the US dollar, you should be able to withdraw an equal amount if you wish to cash out your tokens.


Stablecoins can be backed by:

  • Fiat currencies such as the US dollar, as with USD Coin (USDC);
  • Other cryptocurrencies, such as Origin Dollar (OUSD);
  • Precious metals like gold and silver, as with Paxos Gold (PAXG);
  • Algorithms that ensure their stability, such as DAI or Frax.

Advantages and disadvantages of stablecoins

The most significant advantages of stablecoins are their stability, ease of use, low fees, and fair access to the market for disadvantaged social groups. Many people believe that since stablecoins are less volatile than cryptocurrencies, they might help bridge the gap in the market and make the transition toward a more accessible financial world.


The most notable disadvantages of stablecoins include the involvement of third parties, lower investment returns, and counterparty risks. Furthermore, many question whether stablecoin reserves are sufficient to redeem all of them, which may create a sense of distrust.


Each type of stablecoin has its pros and cons. For example:

  • Fiat-collateralized stablecoins are considered steady but use a centralized structure that requires regulation and auditing, and is vulnerable to cyber threats.
  • Crypto-backed stablecoins are decentralized, free from counterparty risks, and accessible to socially disadvantaged groups, but they are complex to use and dependent on volatile cryptocurrencies.
  • Commodity-based stablecoins (pegged to precious metals) are stable and deemed trustworthy by the general public, but they are centralized and require careful auditing to ensure the authenticity and quality of commodities.
  • Non-collateralized stablecoins are decentralized and run on smart contracts to maximize security, but they are very complex and have a history of failed pegging systems.


Practical use of stablecoins in trading

Many people trade stablecoins like any other cryptocurrency. Exchanges may issue their stablecoins to solidify their market position and attract users who might be hesitant to invest in cryptocurrencies.


Stablecoins are also often used to accumulate savings. Investors from countries with high inflation often convert their money into stablecoins pegged to the US dollar to protect their savings. Some people purchase stablecoins to generate passive income with crypto lending, staking, and interest rates.

Top stablecoins on the market

The most popular stablecoins on the market are pegged to the US dollar and include:

  • USD Coin
  • Binance USD
  • Dai
  • Frax
  • Pax Dollar
  • TrueUSD
  • Gemini Dollar
  • Fei USD

Summary

Stablecoins are cryptocurrencies pegged to other assets (fiat currencies, precious metals, cryptocurrencies, or algorithms) that solve the problem of crypto volatility and may aid the global adoption of decentralized financial infrastructure.

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