Stablecoins: What They Are and Why They Exist
A stablecoin is a utility token built upon another coin’s blockchain. The goal of stablecoins is to create a cryptocurrency that isn’t volatile and doesn’t change price which opens up possible use cases that are not available to other cryptocurrencies while still existing on a blockchain.
They offer the security, privacy, and convenience associated with crypto while maintaining the stability and trust that is often associated with fiat money. Most stable coins are pegged to the US Dollar and therefore equal $1. However, they can be pegged to other currencies from other countries such as the Euro, the Japanese Yen, or any other global fiat currency.
So how exactly do stablecoins work? There are 2 main ways that stablecoins have been implemented so far. The first is through collateralization which means each stablecoin issued is backed by something. The most popular stablecoin to use this method is Tether whose stablecoin USDT is said to be backed by a reserve of US Dollars.
There are many rumors that Tether doesn’t actually hold enough cash reserves to support the collateralization of all circulating USDT. However, it is difficult to prove either way whether or not they actually own the collateral so we will put that aside for now and continue to look at how stablecoins are supposed to work. The other type of stablecoin is controlled by smart contracts and is often referred to as an algorithmically pegged stable coin.
These types of stablecoins are very easy to audit because you can just review the smart contract code and there are no physical assets to steal. They accomplish this by manipulating the supply of their coins to adjust the price with the goal of maintaining it at $1. There are multiple different ways people have tried to implement this idea but currently, there are 3 main algorithms. The first changes the amount of coin in your wallet every time you check to keep the value steady, the second uses a money printer and bond reward system to continuously adjust the price to $1, and the third is very similar to the second but uses something additional called coupons. Three of the top current stablecoins used globally are USDT, USDC, and Dai.
One of the main issues that could potentially arise while using stablecoins is that since they are still relatively new and unregulated so there is no insurance on them. This is in contrast to leaving money in a savings account with a bank that is FDIC insured and is liable to reimburse clients for up to $250,000 worth of funds if they were to be lost or stolen while you left it in the bank’s hands.
At the present time, if the company running these stablecoins were to go bankrupt or out of business, you would most likely be left with nothing. We are now beginning to see the next evolution of stablecoins as countries and governments around the world have begun developing Central Bank Digital Currencies, or CBDCs. The goal of these projects is to incorporate something as close as possible to a traditional fiat currency but in a digital manner that lives on a blockchain.
It will be very interesting to watch how this plays out over the coming years. But one thing is certain, as the adoption and use of cryptocurrencies continue to rise globally tools like stablecoins and CBDCs will play a large role in the on-ramping and off-ramping process between cryptocurrency and traditional institutions.
