Stablecoins — What It Is And How It Works
In today’s post, you will learn what a Stablecoin is and how it works.
Stablecoins are very vital to traders because it helps them protect their crypto assets from dropping in value.
In this post, you will not only learn what stablecoins are but also the similarities and differences between them.
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To walk you swiftly through this post, here is what I will be discussing:
- What Are Stablecoins?
- Types of Stablecoins.
- Lists of Stablecoins.
- Real-World Applications.
What Are Stablecoins?
Stablecoins is a cryptocurrency that is pegged to an asset with a stable value, such as gold or fiat money like the US dollar.
In other words,
Stablecoins is an attempt to create cryptocurrencies that are not volatile (i.e., changes in value consistently).
A stable coin usually has a fixed value to its underlying asset. For example, Tether (USDT) is backed to the US dollars and has a stable value of USD $1 for each USDT token.
A stablecoin should always remain stable in its value despite the crazy volatility of other cryptocurrencies.
Types of Stablecoins
Stablecoins are generally divided into 4 main types or categories.
- Fiat-Backed Stablecoins.
- Commodity-Backed Stablecoins.
- Crypto-Backed Stablecoins.
- Seignorage-Style Stablecoins.
1. Fiat-Backed Stablecoins
The most common type of Stablecoins is collateralized or backed by fiat. ‘Fiat’ is the paper money in your wallet and the digital money in your bank account.
Examples of fiat money include NGN, USD, EUR, GBP, CHF, and JPY.
Fiat-backed stablecoins is backed at a 1:1 ratio, meaning that $1 of a stablecoin is equivalent to $1 of fiat money.
So for each stablecoin that exists in this category, there is real fiat currency being held in a bank account to back it up.
Here are examples of fiat-backed stablecoins;
A well-known or most popular fiat-backed stablecoin is the currency Tether (USDT). Tether is backed by the US dollar, Euro (EU), and the Japanese yen (JP). Its market capitalization is about $4B at the time of writing.
Tether is issued by a company called Tether Limited. It was launched as RealCoin in July 2014 and was rebranded as Tether on 20 November 2014. Tether is also the 3rd biggest coin in terms of the daily trading volume.
Tether is designed to offer stability (like fiat currencies), transparency and lower transaction charges to users.
True USD (TUSD)
TrueUSD (TUSD) is a popular stablecoin that was introduced in early 2018. It was designed to be simple, transparent, and reliable. For this reason, it does not use a hidden bank account.
It is also backed to the US dollar at a 1:1 ratio, which is 1 Tusd represents 1 $. TrueUsd was created as an alternative to Tether because there was a controversy on the transparency of Tether totally back by fiat.
TrueUsd is the first major project built on the TrustToken platform (TrustToken is a platform to create asset-backed tokens).
2. Commodity-Backed Stablecoins
A commodity-backed stablecoin is a digital currency whose value is determined by a real tangible asset. These assets may include gold and other precious metals.
This type of stablecoins is backed by commodities (A valued exchangeable goods or materials).
These commodities may increase in value over time. And this increase gives more rewards to people who hold and use them.
Commodity holders can redeem and take possession of their assets, but it will take days to do so.
An example of commodity-backed stablecoins is;
Digix Gold Tokens (DGX)
DGX is an Erc-20 token backed by physical gold. Each DGX token represents 1 gram of 99.99% LBMA standard gold.
This gold is stored in a vault in Singapore, known as The Safe House. And every 3 months, the gold is being adjusted to ensure transparency (accuracy).
Dgx is created by a company called DigixGlobal. The Digix team was formed way back in 2014.
The value of each Dgx token is fully determined by the market value of gold.
To redeem the physical bars of gold, Dgx holders will have to travel to the vault in Singapore to do so.
3. Crypto-Backed Stablecoins
This Stablecoins is backed by other cryptocurrencies such as bitcoin and ether. In this case, the use of central depositories such as banks is avoided.
This allows for decentralization (having no central authority) since everything is done on the blockchain.
Here is an example of crypto-backed stablecoins;
Dai is a crypto-collateralized asset. It is an ERC-20 token that is created by MakerDao. Dai is pegged to the US dollar to a 1:1 proportion meaning that 1 Dai coin equals 1 USD.
Dai is a cryptocurrency that runs on the Ethereum blockchain and based on this fact DAI is a decentralized cryptocurrency.
4. Seignorage-Style Stablecoins
Seignorage is the only category of stablecoins which is not backed by any asset.
Seignorage coins operate with an algorithmic (accurate step by step) governed approach, just like a central bank that prints more bills.
As the total demand for this coin increases, new supplies are made. This is to reduce the price back to stable levels.
A fine example of a seignorage-style coin is Basis.
This coin was formerly known as ‘Basecoin.’ Basiscoin is a cryptocurrency whose value is backed by the US dollar. This is done through algorithmic adjustments of the coin’s supply.
Price stability is achieved through the monitoring of various exchange rates. If basiscoin is trading above $1, new stablecoins are created and distributed.
If basiscoin is trading for less than $1, base bonds are created and sold.
Lists of Stablecoins
This is the most popular stablecoins in terms of volume in USD as at the time writing.
Tether (USDT) > 22 Million.
TrueUSD (TUSD) > 387 Million.
Paxos Standard Token (PAX) > 216 Million.
USD Coin (USDC) > 140 Million.
StableUSD (USDS) > 1 Million.
I will only explain PAX, USDC, and USDS since I have already talked about Tether (USDT), and TrueUSD (TUSD) earlier.
Paxos Standard Token
Paxos standard token is a fiat-backed stablecoin whose value is backed to the US dollar in a 1:1 proportion. Pax is a cryptocurrency that is regulated and approved by the New York State Department of Financial Services.
As an ERC-20 standard-based token was developed by Paxos Trust Company. Pax tokens can be received and sent by users of an Ethereum wallet.
Pax is also available 24/7 to ensure payments or exchanges of any type of asset.
USD Coin (USDC)
USD Coin is a fiat-backed stablecoin that is backed by the US dollar. This coin is the product of an open-source technology called CENTER.
Usd Coin is an ERC20 token built using the Ethereum blockchain.
Usd coin allows people to use US dollars without requiring a bank account or specific geography.
This coin is regulated, transparent, and verifiable.
StableUsd (USDS) is a fiat-backed or collateralized stablecoin created by Stably.
Each StableUsd token is transparent, legally backed, and redeemable for a US Dollar.
StableUsd tokens are held in an insured escrow account managed by a trusting custodian, such as Prime Trust.
By making StableUsd redeemable and pegged 1:1 with US dollars, we can eliminate volatility.
Stablecoins- despite in its early stage, have many potential real-world applications. Here are just a few.
A Day-To-Day Currency
These coins are used like any other currency for day-to-day purposes. For instance, we can use stablecoins to transfer funds, make a payment, buy pizza, and so on.
Enables Reccuring P2P Payments
Stablecoins also allow the use of smart contracts for p2p (peer to peer) payments. In carrying this out, no third party is needed.
This is beneficial for businesses that have employees all over the world because it reduces fees and long process.
Protection From Local Currency Crashes
Because local currencies like NGN and VEF reduce in value, citizens like you and I could exchange our money to Euro or US dollar to retain its purchasing value.
Likewise, we can convert our fiat currency to commodity-backed stablecoins like gold due to its high stability in value. This protects our life savings from further drops in value.
Many people move to other countries in search of work. These people have families to support back at home.
So sending remittances (transferring money from country to country) overseas is much easier and affordable with stablecoins.
While stablecoins present many advantages, they also have their limitations.
- Fiat-backed stablecoins is centralized, so trust is required.
- For commodity-backed stablecoins, traveling to Singapore is expensive, and could take months to redeem your physical gold.
- Crypto-collateralized stablecoins is backed by cryptocurrencies. Since cryptocurrencies usually fluctuate in value this becomes a problem.
- The base system of Seignorage style stablecoin is complex and difficult to understand.
In this guide, we have finally come to know:
- what a Stablecoin is,
- the 4 different types of stablecoins we have,
- how stablecoins are applicable in our daily lives,
- its limitations and so on.
Now that you have known this, let me know in the comment section
Which stablecoin you will like to try out first?
Did I leave out any important info in this post?
Please, leave a comment if this information was helpful to you, and feel free to ask related questions.
Originally published at nigeriabitcoincommunity.com
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