Bitcoin and other alt-coins are known for their volatility and it’s one of the reasons why they are not adopted as forms for payments. Imagine getting your salary in Bitcoins, but the digital coin drops by a few thousand dollars in value overnight.
Of course, it could also go up by a few thousands. But that’s not enough to use it the same way we do with fiat. And that’s why crypto entrepreneurs created stablecoins, digital currencies pegged 1-to-1 to assets such as the US dollar.
Top stablecoins today
Tether (USDT) is the largest stablecoin today, with a market capitalization of nearly $82.6 billion. So, using Tether to pay for an item costing $1 allows you to actually redeem it on the other end for $1.
Tether is followed by usdcoin (USDC) with a market cap standing at about $50 billion.
Role of stablecoins
Most stablecoins peg to the US dollar or a stable commodity like gold, and other hard assets. The market cap for stablecoins is about $190 billion and growing since more crypto players use them to hedge their investment portfolios.
And, other than helping curtail volatility, stablecoins promote more digital asset trading on crypto exchanges, thus helping making these markets liquid.
For example, many crypto exchanges promote USDT instead of cash currencies, allowing investors to decentralize the transaction, and as such, speed up their trades at less cost. According to Tether, the USDT is 100% backed by reserves that include traditional currency and cash equivalents, counter to allegations to the contrary that surfaced in the past.
Binance’S BUSD is another US dollar-backed stablecoin, this time approved by the New York State Department of Financial Services.
BUSD’s aim is also to increase the speed at which digital assets flow through the global financial network, rather than traders needing to wire fiat currency from their online wallets to make crypto deals.
Same for USDC, it has been used by applications and businesses and runs on many blockchain networks to facilitate easy payments globally.
Using blockchain-based assets is a threat to conventional banking systems as they are much faster, eliminate inefficiencies, are available 24 hours a day, and are encrypted for complete security.
Stablecoins are thus imitating the store of value that government-issued currencies enjoy while integrating all of the advantages that blockchain and cryptocurrencies offer.
A new questionable breed of stablecoins
A new type of cryptocurrency is emerging and seeking to replicate the stability of the US dollar, but observers warn that it’s a runaway train on course for a major crash.
The so-called “algorithmic stablecoins” have surged in popularity in recent months. Let’s take the case of Terra’s algorithmic cryptocurrency UST. It jumped to 3rd place in the ranking of stablecoins having jumped by 14.9% recently, and reaching a market cap of around $18 billion. UST took over 3rd place from BUSD, which currently has a market cap of around $17.5 billion as of April 18, 2022.
Algorithmic stablecoins are pegged to the value systems of other assets via smart contracts that increase or decrease supply, based on current market values.
To compare with collateralized stablecoins, when assets are deposited or withdrawn from reserves, collateralized stablecoins are minted or burned. For example, in the case of USDC, each coin is minted per each $1 USD deposited into their deposits, and one coin is burned for every $1 withdrawn.
Collateralized stablecoins involve liquid assets that can be traded quickly.
Algorithmic stablecoins never use collateral, but rather depend on smart contracts to provide theoretically infinite liquidity.
However, these latter coins can suffer from:
- Exchange rate fluctuations could destabilize algorithmic stablecoins, putting payments and transfers at risk.
- Algorithmic stablecoins depend on foreign data, like exchange rates. Poor data quality, data reporting delays, and data errors can all destabilize algorithmic stablecoins.
- Smart contract risk, or the possibility that bugs occur in the code of their smart contracts, can have disastrous consequences.