In 2020, the world has witnessed an accelerated and inevitable period of development and innovation, including the world of cryptocurrencies. According to the research conducted by the Cambridge Centre for Alternative Finance, the population of cryptocurrency users worldwide has grown from 35M in 2018 to 101M in 2020.
Although stablecoins is one part of the emerging technology, their implementation and influence are becoming more popular than ever. That said, stablecoins are now supported by a growing number of cryptocurrency service providers compared to the previous decade. Also, this booming cryptocurrency already has a market capitalization of almost $25 billion.
Initially, stablecoins were first developed by cryptocurrency investors and fintech companies. However, more and more financial institutions are now jumping into the stablecoins trend. Some of these include Big Tech companies such as Facebook, the Chinese central bank, and JPMorgan Chase.
Despite stablecoin’s growing popularity, many people are still unaware of its existence. Therefore, what are stablecoins and what’s their role in the foreseeable future of the cryptocurrency setting?
Definition of Stablecoin and How It Works
In a nutshell, stablecoins are cryptocurrencies that offer price stability and whose value is pegged to real-world assets, such as gold and oil (exchange-traded commodities), and USD or EUR (fiat currencies). As such, stablecoins are more stable to constant fluctuations in the market. In 2012, the initial concept of developing stablecoins was influenced by the former Mastercoin documentation. However, it was only popularized in 2015 when Tether Limited released the first stablecoin to the public.
In case you didn’t know the definition of cryptocurrencies, they are decentralized, peer-to-peer digital currencies that lets people send instant and anonymous payments to anyone worldwide. Cryptocurrencies utilize and implement encryption keys; hence, making secure and confidential transactions possible for everyone.
In other words, cryptocurrencies, such as Ethereum and Bitcoin, work like digital money that utilizes peer-to-peer networks and abolishes the dependence on a financial institution like central banks. Unlike traditional currencies, cryptocurrencies aren’t regulated and issued by any government and banking institutions.
Like Bitcoin and other types of cryptocurrencies, stablecoins are digital currencies with no physical presence. In addition, they can be traded in a variety of exchanges worldwide.
Many stablecoins are collateralized with specific fiat currencies, such as the EUR and the USD, in a 1:1 ratio. Other types of stablecoins can be pegged to a different kind of asset, such as gold, or other groups of cryptocurrencies. For example, if you purchase one stablecoin that is pegged to EUR at 1:1 where 1 stablecoin is equal to EUR1, then you can sell your stablecoin and claim your EUR1 anytime, anywhere.
What’s the Difference Between Stablecoins vs. Other Cryptocurrencies?
As mentioned, stablecoins are a type of cryptocurrency developed to reduce price volatility associated with a stable asset or basket of assets. That said, stablecoins remain a steady value against a target value. Hence, it’s making stablecoins a highly-valued proposition for many investors and providing a safe haven for merchants wanting to join in the cryptocurrency landscape.
In addition, stablecoins are more viable as an actual currency since they aren’t associated with wild, everyday price fluctuations. Aside from that, they’re essential for all the aspects that people generally use their wealth or assets. As a result, stablecoins allow many practical use cases that common cryptocurrencies can’t, ranging from loans and insurance to investments and payments.
Stablecoins also minimized the resistance by allowing people to use something that they’re already accustomed to, such as the USD, EUR, and GBP. Aside from that, they let users transfer money worldwide instantly while maintaining price stability. Hence, all components are essential to advocating acceptance to everyone in the foreseeable future. With growing evidence that stablecoins are reliable enough to be adopted as a primary medium of exchange, people are going to trust its technology.
In summary, stablecoins are a hybrid between fiat currencies and cryptocurrencies. That said, they have the privacy/security and processing speed of cryptocurrencies, merged with the volatility-free price fluctuations of fiat currencies.
Types of Stablecoins
Stablecoins are categorized into three major classifications. They are the following:
- Algorithmic/Non-Collateralized Stablecoins
- Crypto-Collateralized Stablecoins
- Fiat-Backed Stablecoins
Algorithmic stablecoins depend on the seigniorage share system. As such, they utilize the difference between the cost of printing money and its value. The implementation of smart contracts regulates the process. When the price is below the pegged currency, the stablecoins sell. Otherwise, stablecoins supply more tokens when the price is higher.
Examples of Algorithmic Stablecoins:
Crypto-Collateralized stablecoins is supported by digital currencies or cryptocurrencies. That said, it’s possible to maintain a 1:1 ratio through over-collateralization. Some of the crypto-collateralized stablecoins’ advantages include faster regulation, higher liquidity, transparency, and decentralization.
Examples of Crypto-Collateralized Stablecoins:
- Money On Chain
From the name itself, fiat-collateralized stablecoins are backed by fiat currencies. Generally, they are associated with the US Dollar. Hence, the value is permanent at a 1:1 ratio. Since cryptocurrencies have very complex systems, fiat-collateralized stablecoins are easy to understand. Aside from that, they’re more stable compared to the other two types of stablecoins.
Examples of Fiat-Collateralized Stablecoins:
- USD Coin
- Tether (USDT)
- PetroDollar (XPD)
- Gemini Dollar
Without a doubt, stablecoins will eventually become a major cryptocurrency in the foreseeable future. As such, they’ll revolutionize the way people perceive cryptocurrencies. In addition, stablecoins have helped in advocating long-term use and adoption since they reduced the barrier that has held cryptocurrencies from being recognized and used as part of a daily currency.
Read Next Blog: What Does The Future Hold For Bitcoin
Cryptocurrencies are definitely here to stay. And it’s looking significantly more evident that stablecoins are the answer to eliminating doubts, accelerating cryptocurrency’s stability, and eventually, empowering the future of currencies in a digital world. That said, they paved the way for cryptocurrencies to become more acceptable and mainstream to the public. With people and businesses finding better, easier, and more affordable methods of transferring payments worldwide, stablecoins have bigger potential for development.