Stablecoins are cryptocurrencies the price of which is pegged, linked or otherwise tied to that of another currency or asset. They offer stability over volatile digital currencies like bitcoin, which have been blamed for causing recent market crashes.
The idea behind stablecoins is simple: rather than having to worry about whether the cryptocurrency you buy today will still be worth something tomorrow, it makes sense to invest in something that you know will always retain its value.
While there are several different types of stablecoins, each one aims to solve a specific problem. For example, Tether claims to be the world’s largest stablecoin issuer, while TrueUSD is designed to make it easier for consumers to switch banks without losing access to their money.
Types of Stablecoins
There are three main ways to achieve stability in cryptocurrencies: peg, bond, and reserve. A pegged currency maintains a fixed exchange ratio against another asset, like gold. For example, Bitcoin Cash (BCH), Litecoin (LTC), Ethereum Classic (ETC), Zcash (ZEC), and Monero (XMR). Bonded currencies use special mechanisms to maintain price stability. They often require collateralization, such as Tether (USDT), TrueUSD (TUSD), Dai (DAI), Gemini Dollar (GUSD), Paxos Standard Token (PAX), Circle USD Coin (USDC), and Maker (MKR). Reserve currencies are backed up by reserves held outside of the financial system, such as the Federal Reserve Note (FRN) and the Euro (EUR). Examples include Ripple (XRP), Stellar Lumens (XLM), Basic Attention Token (BAT), and EOS (EOS).
Fiat-Collateralized Stablecoins
1.A stablecoin is a digital asset designed to provide price stability. They promise to maintain a constant value against another asset, usually a sovereign currency, such as the U. S. dollar.
2. There are several types of stablecoins.
3. One type uses fiat money — government-backed currencies like the United States Dollar (USD).
4. Another type uses cryptocurrencies, including Bitcoin, Ethereum, Litecoin, Ripple, Stellar Lumens, EOS, and others.
5. Cryptocurrencies tend to fluctuate wildly.
6. For example, during 2018, the price of Ether, the native token of the Ethereum network, rose from around $20 per coin to over $800 per coin.
7. This volatility makes it difficult to use cryptocurrencies as a store of value.
8. Stablecoins offer an alternative solution. Instead of holding volatile assets, people can hold stablecoins, which promise to maintain a certain value relative to traditional currencies.
9. These stablecoins are often tied to a specific currency, such as USD.
10. The idea behind stablecoins is simple: you don’t want to lose money because of fluctuations in the value of the underlying asset.
11. But there are some challenges involved.
12. First, how do you ensure that the value of the stablecoin stays pegged to the underlying asset?
13. Second, what happens if the underlying asset loses value?
14. Third, how do you prevent people from creating additional stablecoins?
15. To address these questions, stablecoins typically rely on a combination of three different approaches.
16. First, stablecoins may require a central entity to guarantee the value of each stablecoin.
17. For instance, Tether claims to be fully regulated by New York state authorities.
18. In addition, the Reserve Bank of Australia regulates the Australian Digital Currency Token (ADCT), while the Monetary Authority of Singapore oversees the issuance and regulation of the Lion Coin.
19. Second, stablecoins may require users to deposit their own funds into a smart contract.
20. For example, the DAI protocol requires users to lock up ETH or other tokens before they receive DAI.
21. Finally, stablecoins may have built-in limits on the number of coins that can be created.
22. For example, the Maker Protocol allows only 21 million MKR tokens to ever exist.
23. Each approach has its advantages and disadvantages.
24. For example, a centralized model offers more security but also creates a single point of failure.
25. On the other hand, decentralized models make it easier for new projects to enter the market.
Crypto-Collateralized Stablecoins
The concept behind crypto-collateralized stable coins is simple: you take the underlying asset like Bitcoin or Ether and use it to collateralize a digital currency called a stable coin. These stable coins are designed to maintain a fixed exchange rate relative to fiat currencies like the US Dollar. They do this by being tied to the value of some reference asset, usually another type of cryptocurrency.
This allows investors to buy into the stable coin without having to worry about fluctuations in the market value of the underlying asset because they know that the stability of the stable coin is guaranteed by the underlying asset.
Algorithmic Stablecoins
The term “stablecoin” usually refers to digital currencies pegged to fiat currencies like the U.S. Dollar. But there are several types of algorithmic stablecoins out there too. They’re called “algorithmic,” because they use algorithms to control the amount of money being minted every day, month, quarter, etc., to keep the value of each coin constant relative to another.
One type of algorithmic stablecoin, known as a “fiat-collateralized” stablecoin, uses real-world assets like gold or silver as collateral backing its value. Another type, known as a “non-fiat-collateralised” stablecoin, doesn’t require any real-world assets to serve as collateral. Instead, it relies on mathematical formulas to determine how much money to issue and how many coins to mint.
In theory, both kinds of algorithmic stablecoins could help stabilize cryptocurrency prices during times of market volatility. But the fact that the value of those currencies depends entirely on the stability of the underlying asset — whether it’s gold or bitcoin — makes them less useful in a crisis. If the value of the underlying asset collapses, so do the stablecoins’ values.
Stablecoin Regulation
The debate over regulating stablecoins is heating up again. This time around, IOSCO, the international organization of securities commissions, wants to regulate cryptocurrency-based stablecoins.7
In a statement published Oct. 8, IOSCO said it is concerned about the growing popularity of stablecoins, especially those tied to fiat currencies like the dollar and euro, since they could pose risks to the global financial system.8
“We are concerned that stablecoins, particularly those pegged to fiat currencies such as USD and EUR, are becoming increasingly popular among investors and traders alike,” IOSCO said.9
While IOSCO did not specify what types of stablecoins it considers systemically important, the group said it is worried about the lack of transparency and oversight in the industry.10
“Given the fast pace of innovation and expansion of the crypto asset ecosystem, we believe that there is a need to take action now to ensure that the crypto asset markets remain well-regulated and safe,” IOSC0 said.11
Regulation of stablecoins could help protect consumers, according to IOSCO.12
“If properly structured, stablecoins could offer significant benefits to both consumers and businesses,” IOSCC said.13
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