When you look at the top cryptocurrencies by market cap, 2 of the top 5 assets are stablecoins. Regardless of how long you’ve been dabbling in digital assets, you’re well aware that they are volatile assets, but that’s what makes investing in them so enticing, as you could make a lot of money in a short time. So why then, are two of the most popular digital assets ones that can’t change in value?
Well, because the ups and downs of the digital asset market are all but guaranteed, stablecoins are then a way to buy crypto with no volatility, or hedge when you feel that your favorite coin or token is due for a drop in price. Let’s talk more about what stablecoins are before further discussing why they’re so heavily used.
What Are Stablecoins?
Stablecoins are digital assets that attempt to offer price stability in response to the inherent volatility experienced by most cryptocurrencies. This is done by pegging the digital assets value to something more stable, such as fiat currencies like the USD.
The stablecoins are then collateralized by having a backing of assets held in reserve, for example if a company issues $1 million in USD stablecoins then they should also hold $1 million USD in reserve for you to then redeem the stablecoin for fiat.
Types of Stablecoins
There are three main types of stablecoins: fiat-backed, crypto backed, and commodity-backed. There’s also algorithmic stablecoins, which are riskier.
An example of a fiat-backed stablecoin is something like Tether (USDT), TrueUSD (TUSD), or USD Coin (USDC). These stablecoins are backed by reserves of fiat in the form of US dollars. There are stablecoins pegged to the most common fiat currencies such as the Euro or British Pound, the difference being that they’re backed by reserves in that currency. All fiat-backed stablecoins should be redeemable for the actual fiat currency, like with Tether.
An example of a crypto backed stablecoin is Multi-collateral Dai (DAI). These types of stablecoins are issued by using cryptocurrencies as collateral. However, because of the inherent volatility of using an unstable asset such as Bitcoin as collateral, you often need to hold a much greater collateral ratio than you would when compared to a fiat-backed stablecoin. With those you simply pay an equivalent amount in fiat to receive the stablecoin.
Commodity-backed stablecoins are collateralized by commodities such as gold or silver. These types of commodities are much less likely to experience inflation the way fiat-backed stablecoins can. This is due to the inability to create more gold and silver in contrast to the ability to print more money. Commodity-backed stablecoins should theoretically be redeemable for the real asset, meaning the company who issues the stablecoin needs to maintain, store, and protect the commodity to ensure equivalent reserves for potential redemption of all stablecoins issued.
Algorithmic stablecoins are a bit of a taboo in the digital asset sector due to the epic collapse of Terra USD (UST) in spring of 2022. They work by relying on two tokens: one stablecoin and another cryptocurrency that backs the stablecoins, and an algorithm (or the smart contact) regulates the relationship between the two. DJED is an algorithmic stablecoin on Cardano that works in this manner. Whether it’s able to save the public image of algorithmic stablecoins is yet to be seen, but there’s no logical reason why a properly designed algorithmic stablecoin couldn’t work.
Why Use Stablecoins?
One of the most popular uses for stablecoins is to use them to hedge against volatility, essentially shorting digital assets. Since stablecoins experience little fluctuation, digital asset holders can mitigate losses during a bear market by turning their unstable cryptos into stablecoins and waiting out the market.
Similarly, if they feel the value of a cryptocurrency they hold is going to drop, they can convert it all into stablecoins and then buy back the asset at a cheaper price. Keeping profits as stablecoins is also a good way to lock in a return on an investment without risking a drop in price, rather than putting profits into a stock or other digital asset.
Another popular use for stablecoins is for payments across borders (remittances). If you want to send someone USD who lives in another country, the fees for sending stablecoins on a blockchain network are far lower than if you were to send a fiat money transfer through something Western Union. The stablecoins are also sent nearly instantaneously. The ability to do this is extremely beneficial for those in countries where it’s difficult to send or receive money without being charged exorbitant amounts in fees and conversions.
Finally, stablecoins are a popular way to pay people within the cryptocurrency sector. If you are paying developers in the asset they are working with (such as paying a Solana developer in SOL), it can lead to dumping of the asset when they need to pay their bills. It could also result in a loss in value overnight due to the volatile nature of non-stablecoin assets, which would essentially mean they have been underpaid. By paying people in stablecoins you can provide stability to both the asset they are helping to develop, and to the employee’s financial situation.
Closing Thoughts: The Solution for Crypto Volatility
As digital assets become more popular and as governments consider the idea of Central Bank Digital Currencies (CBDCs), it seems likely that stablecoins will remain an extremely popular aspect of the crypto sector.
There are a variety of ways in which to use them to your benefit, and they’re a stable investment. Whether you need to lock in profits or send money to your family on the other side of the world, there is a place for stablecoins in most portfolios.
