Stablecoins have been available in the market for over a decade now. As the name suggests, stablecoins were introduced to the world in 2014, as a stable alternative to the highly volatile and fluctuating traditional cryptocurrencies.
As we all know, nothing stays constant in the world of cryptocurrencies. The value of a cryptocurrency sways so dramatically that it is usually not preferred as a means of usual transactions. And here comes stablecoins. On paper, it is a digital currency like cryptocurrencies but a less volatile one.
According to recent reports, the stablecoin market is growing rapidly with 27.5 million active users and the number of stablecoin transactions is also increasing.
Today, there are about 200 stablecoins available in the market. Some of the popular ones include Tether (USDT), Dai, USD Coin (USDC), and Binance USD (BUSD).
In this article, we will discuss what stablecoins are, how they work, categories, and more to understand the importance of stablecoins and why you should know about them. So, without further delay, let’s get into the crux of the matter.
What Are Stablecoins?
Stablecoins are a type of cryptocurrency pegged to any physical asset of value. Typically stablecoins are tied with fiat currencies or commodities, but you may also find some that are tied to other cryptocurrencies.
This means that the value of the stablecoins is fixed according to the assets they are tied to. For instance, USDT – one of the most popular stablecoins in the market is tied to the US dollar. Each token of USDT has a value of $1 at all times.
In essence, it will take out the volatility that traditional cryptocurrencies are famous for and serve as a reliable payment method for goods and services.
While stablecoins might not excite professional traders who make a profit by making quick decisions according to market trends, they serve as a stable digital asset in the long run.
That being said, stablecoins are not actually “stable” There have been instances where stablecoins lost their peg with the commodities they are tied to. The most famous example is of course the very first stablecoin introduced to the market – BitUSD. It lost its peg to the US dollar within four years of its launch and never recovered.
So, it needs careful consideration and an-in-depth knowledge about different kinds of stablecoins, before hurrying to be an early adapter and investing in stablecoins.
How Do Stablecoins Work?
A stablecoin is a cryptocurrency pegged to a real-life currency such as USD, Euro, and Australian Dollar, or commodities such as gold and oil.
This pegging is what makes these kinds of cryptocurrencies more stable than other cryptocurrencies like Bitcoin (BTC), and Ethereum (ETH). Let’s see how stablecoins work, by diving into the technical aspects of the concept for a bit.
Like cryptocurrency, stablecoins are digital assets that are created and monitored by a private entity. It is only available in the digital space, but you can exchange it for other assets or cash it out to your bank account.
The private entities issue a stablecoin and store either commodities or currencies of the same value, this is the ‘pegging’ or tying process.
If the stablecoin is pegged to dollars, the issuer will hold the value of the tokens issued, in dollars. This means that the stablecoins will hold their value in the long run regardless of external factors.
You can own stablecoins and store them on digital wallets protected by multi-factor authentications. In addition to storing, these crypto wallets may also allow you to transfer and receive stablecoins.
You can use stablecoins as a means of exchange for commodities and services, or invest it to make a profit out of it.
Why Are Stablecoins So Important? Why Are They Gaining Popularity?
To learn the importance of stablecoin, we should know the fundamental flaw of cryptocurrency. Being a digital currency, that has no ties to any real-world assets, its value fluctuates to its demand
The more the demand, the higher the value, and vice versa. This makes it almost impossible to predict who will benefit from a cryptocurrency transaction, the buyer or the seller.
The closing value of Bitcoin in March 2024 was more than seventy thousand dollars, but it went down to $63,755.32 in just 26 days. So, if a person has exchanged a real-life asset for Bitcoin and held on to it without cashing, he would’ve lost nearly a thousand dollars. You may also remember the story of Lazlo Hanyecz, who spent 10,000 Bitcoins just for two Papa John’s pizzas.
This is where the importance of a stablecoin lies. Due to its nature of holding its value, in the long term, it can be used as a means of transactions such as purchases or compensation for service.
While the value of a cryptocurrency may fluctuate about 10% within an hour, even a 1% variation is rare in fiat currencies and stablecoins.
While the concept of stablecoins is relatively new to the world, its popularity is growing for these reasons:
1. Ease of use
Unlike cryptocurrencies, stablecoins are easy to use in day-to-day life. It can be transferred quickly, and securely, because they can be accessed from anywhere, with internet access. Additionally, the stablecoins have a smaller transaction fee in comparison.
2. Acceptance
With stablecoins, you will be able to purchase other cryptocurrencies of your choice. This is especially helpful if the particular cryptocurrency you are interested in does not accept the transaction with the fiat money of your country.
3. Accessibility
The stablecoins are more accessible than other cryptocurrency counterparts. You can purchase stablecoins with almost all of the major hard currencies in the world.
4. Low risks
Since stablecoins are far less volatile and hold their value than other cryptocurrencies. Many people prefer using stablecoins as a long-term investment and for everyday transactions.
Types of Stablecoins
As we have mentioned before, according to the nature of the pegged asset, stablecoins can be categorized into four. Let’s see what they are and how they differ from each other:
1. Fiat-backed stablecoins
One of the most popular forms of stablecoins is fiat-backed stablecoins. These are cryptocurrencies that are tied to any fiat currencies in the world. Due to USD’s better acceptance worldwide, most fiat-backed stablecoins use US dollars as their collateral.
The collateral is regularly audited by independent auditors to maintain the transparency and trustworthiness of a stablecoin. Some of the most popular fiat-backed stablecoins include USDT, USDC, BUSD, GUSD, and PAX.
2. Commodity-backed stablecoins
Cryptocurrencies pegged to a real-life commodity such as gold, silver, or oil, belong to the category of commodity-backed stablecoins. Here, the issuer holds the value of the stablecoin by employing third-party custodians or by investing in instruments that hold them.
Commodity-backed stablecoins worth mentioning include PAX Gold (PAX G), and Silver Token (SLVT). This type of cryptocurrency may also allow the user to exchange the real commodity for the stablecoins they own.
3. Crypto-backed stablecoins
A crypto-backed stablecoin is similar to fiat-based stablecoins but uses an existing cryptocurrency as collateral. Since the value of the reserve cryptocurrencies may vary dramatically, most of such stablecoins are over-collateralized. This means that the collateral in reserve exceeds the actual value of the stablecoin.
One of the biggest examples of crypto-backed stablecoin is DAI. it maintains a value of $1 and uses cryptocurrency in its reserve as the collateral. Most of the crypto-backed stablecoins store cryptocurrencies worth two times the actual value of the stablecoin.
4. Algorithmic Stablecoins
Algorithmic stablecoins work by a preset computer program to maintain a stable value. While some stablecoins that belong to the category may reserve collateral, most of them do not. The algorithm controls the stablecoin’s supply through a preset formula. This essentially means that the value of algorithmic stablecoins is heavily dependent on market demands.
While the transparency and decentralization nature of algorithmic stablecoins may attract investors, if the demand decreases below a certain threshold, the entire system can falter. There are many such examples before us, including the infamous plummet of Terr-Luna cryptocurrencies.
Stablecoins Vs Altcoins: Understanding the Differences
While we are discussing what stablecoins are, we should also address what are the differences between the concepts of altcoins and stablecoins. Any kind of cryptocurrency that is not Bitcoin is called an altcoin.
Altcoins are introduced as an alternative to Bitcoins hence the name. Some of the most popular altcoins include Ethereum, Tether, Dogecoin, Binance Coin, Ripple, Cardano, and Tezos.
Based on the functionalities, utilities, features, and genre, the altcoins can be further categorized into several subcategories such as stablecoins, meme coins, governance tokens, and more.
Thus, stablecoins also come under the umbrella term ‘altcoins’. While all stablecoins are altcoins, the altcoins that are pegged to other form assets are considered stablecoins.
Unlike other altcoins, stablecoins are designed to hold a comparatively stable value by reserving collaterals. The collaterals can vary from fiat currency, and commodities, to other cryptocurrencies. Examples of stablecoins include USD Coin, Dai, Binance USD, TUSD, and more.
Stablecoin Regulations
Stablecoins have come under scrutiny in many instances for the violation of government regulation. However, issues with government regulations are not new in the world of cryptocurrencies. The regulations change according to the countries you reside in.
But as far as the International Organization of Security Commissions (IOSCO) goes, the stablecoins should come under financial market regulations to inhibit their potential growth that can affect the broader financial system.
Additionally, several sources reported on June 27th that the European Union’s restrictive stablecoin regulations are about to become effective soon.
According to the upcoming EU regulations, stablecoins are banned from having over 1 million daily transactions that pay for goods or services settled off and on-chain.
Moreover, the Lummi-Gillibrand Payment Stablecoin Act was enforced in the US to promote the dominance of the US dollar.
The act imposes strict measures for ensuring consumer protection, illicit finance prevention, preserving the dual banking system, and protecting the American dollar’s dominance in the digital economy.
So, the regulations vary according to your geographical location. Some of the countries have more advanced and innovative financial sectors and more open government regulations. The pioneering markets of stablecoins include the US, Switzerland, China, and Nigeria.
Top Stablecoins
We have seen what stablecoins are and why it is important in the market to have a more stable version of cryptocurrency.
It enables faster and more seamless transactions, typically the transaction fees are low, easily accessed from anywhere with an internet connection, used for international purchases, provides a level of privacy, and has built-in blockchain security.
However, not all stablecoins operate the same and they are not accepted the same. We have already seen different categories of cryptocurrencies, and how unique they are from each other.
Here, you can see the top 10 stablecoins listed according to their market cap as of July 1st, 2024.
| Sl. No | Name | Category | Pegged Asset | Market Cap (USD) |
| 1 | Tether (USDT) | Fiat-backed | US Dollar | 112,783,119,372 |
| 2 | USDC (USDC) | Fiat-backed | US Dollar | 32,317,226,727 |
| 3 | Dai (DAI) | Crypto-backed | US Dollar | 5,348,565,217 |
| 4 | First Digital USD (FDUSD) | Fiat-backed | US Dollar | 2,073,471,838 |
| 5 | SUSDD (USDD) | Algorithm-backed | US Dollar | 733,872,403 |
| 6 | TrueUSD (TUSD) | Fiat-backed | US Dollar | 494,895,450 |
| 7 | PayPal USD (PYUSD) | Fiat-backed | US Dollar | 423,569,650 |
| 8 | Ethena USDe (USDe) | Algorithm-backed | US Dollar | 3,602,972,979 |
| 9 | USDB USDB | Proof-of-burn | US Dollar | 391,402,324 |
| 10 | Ondo US Dollar Yield (USDY) | Yield-bearing | US Dollar | $180,165,479 |
It is important to note that all the top 10 stablecoins are pegged to the US Dollar. This is due to the wide acceptance of the dollar in the global market and the open financial regulations of the US Government.
However, not all of the above stablecoins use US dollars as collateral. For instance, DAI reserves cryptocurrencies as collateral. Whereas algorithm-backed stablecoins such as USDD use smart contracts and supply-demand mechanisms to maintain their peg.
While on paper, the stablecoins are expected to maintain a 1:1 peg with the US dollar. In reality, the value fluctuates.
Why do Stablecoins backed by USD fluctuate in price?
While stablecoins are supposed to maintain a stable value all the time, even the most popular stablecoin’s value fluctuates slightly.
Though these fluctuations are often far less than 0.1%, there have been instances where the stablecoins lost their peg with the US dollar beyond recovery. Some of the famous examples include the collapse of TerraUSD and BitUSD.
Additionally, some stablecoins have lost their peg temporarily and recovered completely, examples include USDC, DAI, and Tron’s USDD.
The fluctuations in the value of stablecoins may happen due to several reasons such as:
- Demand: One of the major aspects that can affect the value of a stablecoin is its demand in the crypto market. If there is a higher demand than the supply, the value can go high and vice versa.
- Fluctuations of Other Cryptocurrencies: Stablecoins that are backed by other cryptocurrencies will suffer when an unanticipated swing occurs in the value of their cryptocurrency assets. For example, the price of TerraUSD (UST) fell by more than 60% in May 2022 after the price of the related Luna token dropped more than 80% overnight.
- External Influences: Like other cryptocurrencies, stablecoins are also affected by some external factors such as government regulations, media coverage, and many other factors. To quote an example, the USD Coin temporarily lost its peg to the US dollar when the Silicon Valley Bank collapsed, because a part of the reserves were held in the bank.
How to Choose the Best Stablecoin?
If you are interested in investing in a stablecoin, you should have complete clarity on what your objectives and financial goals are. For instance, if you are looking for a long-term digital investment, then you may have to look for stablecoins that are most transparent and stable.
But if your goal is to make a profit out of exchanging and trading the token you own, you might want to weigh in its acceptance and overall market demand. Some of the factors that you should generally consider before investing in a stablecoin include:
Stability
Evaluate the stability mechanism of the token you are considering. Typically, stablecoins that use fiat currencies as collateral are more stable than algorithm-backed stablecoins.
Liquidity
Choosing stablecoins that have high liquidity means that you will be able to buy and sell large amounts without significantly affecting their value.
Transparency
Stablecoins should offer a level of transparency in their mechanism and how prompt they are with the reserves by employing independent auditors. The more the transparency, the more stable they can be.
Acceptance
Choose a stablecoin that is widely accepted in the exchange platforms and other financial platforms, if you are planning to use the stablecoin as a means of transaction.
Regulation
Ensure that the stablecoin you are choosing adheres to the regulations of a competent international authority or government institution. While it may affect the anonymity of the user, it assures a level of credibility and accountability.
These are just some of the aspects you should generally consider when choosing a stablecoin. However, the criteria can differ according to your specific objectives and targets.
Moreover, it can be a smart strategy to diversify your investment to mitigate the risk. Do a thorough investigation and stay updated with the market trends. Consult a personal financial advisor if needed.
Conclusion
Cryptocurrency is a rapidly growing world of digital assets. Its decentralized approach makes it a popular choice for international trading and long-term investments.
However, the cryptocurrency market is highly volatile and the risks associated with the loss of your investment are very high. This is where stablecoins, come in.
Stablecoin stands as a more stable alternative to the traditional cryptocurrencies. It works by pegging its value to other assets including fiat money, commodities, and cryptocurrencies.
Depending on the type of reserve they use, stablecoins are categorized into fiat-backed, crypto-backed, and algorithm-backed. While stablecoins come under the umbrella term of ‘altcoins’, not all altcoins are stablecoins. Some of the top stablecoins are – USDT, USDC, DAI, FDUSD, and USDD.
While stablecoins are supposed to preserve their value at all times, the value may fluctuate due to market demand, fluctuations in other cryptocurrencies, and external factors such as media coverage, popularity, and government regulations. Some of the countries that are pioneers in the stablecoin market include the USA, Switzerland, and China.
It is best to choose a stablecoin after considering its stability, transparency, liquidity, acceptance, and regulatory adherence. Consulting a financial advisor, diversifying your portfolio, and staying on top of the market trends may help mitigate the risks associated with stablecoins.
