Amid a collapse in the digital asset market in 2018, which saw bitcoin lose 80 per cent of its value, many investors have moved into stable coins, which have been described as the “holy grail” of cryptocurrencies. Here is what you need to know about stable coins:
What is a stable coin?
A stable coin is a cryptocurrency pegged to another stable asset, such as gold or the US dollar. While conventional digital money like bitcoin is highly volatile, stable coins are generally traded at a fixed price.
Why are they useful?
Right now stable coins typically serve as a gateway for investors to enter the crypto-asset market.
Most cryptocurrency exchanges in the world only allow users to trade one digital token for another. That is because converting fiat currencies into cryptocurrencies is a relatively complicated matter, which involves dealing with banks and regulators in different jurisdictions.
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If you want to buy a cryptocurrency for the first time, one of the easiest ways to do so is to turn your money into stable coins via fiat-to-crypto exchanges, such as US-based Coinbase and Hong Kong-based Coinsuper. With your stable coins, you can then jump onto bigger platforms, such as Binance, where you can trade hundreds of digital tokens.
If you decide to exit digital tokens because of volatility or another reason, you can trade them back for stable coins without having to move any money back to the fiat world.
But the use cases for stable coins go beyond being a simple gateway to the trading of digital tokens.
Stable coins can be used for everyday transactions, such as buying coffee, paying salaries or buying real estate — facing fewer barriers to mass adoption than traditional cryptocurrencies, which often come with low transaction speeds and high fees in addition to current volatility.
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What are the different types of stable coin out there?
The most common type of stable coin is backed by US dollars or other fiat currencies at a 1:1 ratio. The coin issuers hold the same amount of fiat money in their bank accounts – think of them as IOUs redeemable for the underlying assets.
The market leader in this category is Tether, or USTD, issued by the US-based start-up Tether Limited. However, after the company failed to provide an independent audit report, the price of Tether dipped to US$0.90 in October as investors questioned whether it is fully backed by US dollars. Still, Tether remains one of the most-traded cryptocurrencies with a market value of US$2 billion.
Rival US dollar-backed stable coins such as Gemini, TrueUSD, USDC, and Pax are issued by companies regulated in the US, and auditing is generally more transparent. All these offerings are available on most exchanges.
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The second type of stable coin is still pegged to the US dollar at a 1:1 ratio but the underlying collateral is other cryptocurrencies, such as ether. Every step of coin issuance is completed via a set of protocols executed on blockchains. A cryptocurrency investor is required to deposit, or lock up, an amount of ether that is worth more than the stable coin they will get in return. The over-collaterisation is intended to act as a buffer to daily price swings in ether.
There is no auditing required because everything happens on the blockchain. Popular examples include MakerDAO’s DAI and Havven’s nUSD.
The third model has no collateral at all. As crazy as the idea might sound, these stable coins use blockchain-based algorithms as a kind of central bank, whose sole purpose is to control the ‘money supply’ to make sure the coins will always trade at US$1. Examples of algorithmic stable coins include Basis and CarbonUSD.
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What is next for stable coins?
Some researchers have indicated that stable coins are not the only solution to volatility in the digital asset market – insurance policies and derivative products from the traditional world of finance can also do the job. And there appears little demand for multiple forms of stable coins and as such, weaker projects will likely get edged out of the market by the strongest.