Chaos and confusion are rising with the surge in popularity and knowledge of Cryptocurrencies. Despite their popularity, there is still one fundamental problem with cryptocurrencies like Bitcoin, Ethereum, and many others, and that is their volatility. Therefore, mainstream investors and non-technical individuals may avoid such cryptocurrencies because of their volatility. There was a need for a coin that could be as safe and non-volatile at the same time — stablecoins.
Stablecoins are a token-like digital currency that offers a glimmer of optimism for the day when cryptocurrencies will be as widely accepted as cash. Why is this the case? Let’s be quite clear about what we’re dealing with here!
What are Stablecoins?
Stablecoins are, as their name suggests, coins that are stable! And the concept is fairly straightforward.
A stablecoin is issued on a blockchain and has the same characteristics as any other cryptocurrency would, except for one condition – the stablecoin can only be issued (sometimes known as “minting”) when the issuer receives or takes custody of an asset that the stablecoin represents. This is known as “1:1 backing” and allows the stablecoins price to remain tied to the value they represent.
For example, if a consumer wishes to receive $100 worth of a US Dollar backed stablecoin, the consumer would pay an issuer US$100. In return, the issuer would mint US$100 of their stablecoin and send this to the consumer. Regardless of what the consumer does with their stablecoin (spend it, save it, trade it, or even lose it) the US$100 that backs it will remain in the custody of the issuers bank account until such a time the US dollars backing it is requested by the current stablecoin holder – this process is known as “burning” or “redeeming”.
While the example above depicts a USD-backing of a stablecoin, the type of asset backing the stablecoin is interchangeable. Whether it represents another fiat currency such as the AUD, GBP or EURO, or a commodity such as Gold, Silver, or Oil, the fundamentals remain the same – the stability comes through its 1:1 backing of the asset it represents.
How Many Types of Stablecoins Are There?
There are four different kinds of stable coins, each having its own significance:
Fiat-collateralised Stablecoins
Fiat-collateralised Stablecoins are built on the foundation of the US dollar, which is used as a form of collateral.
The structural benefit of fiat-backed stablecoins makes them one of the basic pillars of stablecoins. In order to have a better understanding of cryptocurrency, simplicity is the most significant benefit, which fiat-collateralised stablecoins provide. There are two prominent stablecoins: USDT and BUSD, both of which are fiat currencies with a value equal to one US dollar.
Commodity-backed Stablecoins
Commodity-backed stablecoins are backed by a variety of tradable goods, including precious metals. Gold is the most commonly utilised collateral for stablecoins backed by commodities, as it cannot be diluted.
Because of this, commodity-backed stablecoins are very popular with commodity investors since they don’t have to deal with the inconvenience of procuring and keeping metal themselves. You can’t go wrong with Paxos Gold (PAXG) or Tether Gold (XAUT) which are two of the most common community-backed stablecoins.
Crypto-backed Stablecoins
Stablecoins that have been supported by other cryptocurrencies are known as crypto-backed stablecoins.
Crypto-backed Stablecoins have the same principle as stablecoins backed by fiat currency: the value stays the same no matter what happens to the underlying asset. Ethereum is typically the cryptocurrency of choice for crypto-backed stablecoins. Wrapped Bitcoin (WBTC) is an example of stablecoins backed by Bitcoin that was released on the Ethereum network.
Algorithmic Stablecoins
Algorithmic stablecoins would be the fourth type of stable coin to be added. It is one of the stable coins that are most different from the rest. But what’s so different about it?
Instead of using physical assets to support their value, algorithmic stablecoins use an algorithm to give traders a reason to keep the price stable. Non-collateralised stablecoins, which work like a central bank, are used to keep the price stable even though there are no reserves. Popular algorithmic stablecoins include DAI, Frax and FEI (and Terra’s UST until recently). These algorithms are often paired with game theory to incentivise the price to remain at a certain point.
Now that you know what stablecoins are and how they work, let’s look at why they are so popular.
Why it's Important to have a Stablecoin on Multiple Blockchains
If you’re going to use stablecoins, you may as well buy them on various blockchains to mitigate risk. PayPal is already looking for ways to enter the stablecoin industry. New stablecoins are being launched, and some of them are pretty interesting. Recently, we even announced an Australian Dollar-backed stablecoin (AUDD) that will be available on multiple blockchains such as ERC-20 and the Stellar network.
Why are Stablecoins Getting Popular?
Mitigate the Risk
One of the major reasons why stablecoins were created and are getting such popularity is because they were made to reduce the risk that comes with cryptocurrencies and to make a digital currency that can be used and is backed by real money.
As a reason, stablecoins can be used as a liquidity indicator, since they are meant to maintain a constant price. Market participants use them to purchase other cryptocurrencies on markets that don’t take fiat currency and to save money in case the value of other cryptocurrencies goes through a significant fluctuation.
An Important gap in the Crypto Industry
A problem that many well-known cryptocurrency exchanges around the world face are the inability of investors to purchase their desired cryptocurrencies using hard currencies, such as dollars, euros, and others.
Cryptocurrency exchanges have been avoided by many institutions because of concerns about money laundering. But with the rise of stablecoins, it can be the saviour for investors as it will allow them to communicate and work directly with the banks, making things transparent and efficient.
Ease of Use
It is more stable than its cryptocurrency equivalents and is only one of several features that makes day-to-day usage simpler. Stablecoins are available in four different varieties, ensuring that there is always something for everyone. Also, they can be transferred quickly, cheaply, and securely is a boon.
They are internet-ready and may be programmed to meet specific requirements. When using stablecoins, you may access it from anywhere and anytime, considering you have an internet connection. Ultimately, these user-friendly features will attract new customers and allow for greater diversification in payment.
Access to Open Banking
Open banking is more possible because of the decentralisation of banking and the improved stability of stablecoins. Using third-party applications, users can access their bank and financial account information through an open banking system, which allows them to utilise stablecoins in their day-to-day lives.
Stablecoins for Australia
In a recent ASX announcement, Novatti shared the exciting news that it would be launching an Australian Dollar backed stablecoin leveraging the Stellar blockchain. The stablecoin – which has been called AUDD – would allow its users to pay, and be paid with the speed, security, and transparency of a blockchain-based crypto asset, without the concern of price volatility or transaction fees.
How does AUDD fit in?
As we discussed earlier, decentralised markets can be very volatile. By implementing such stablecoins into decentralised trading environments, investors and traders can enter and exit a volatile cryptocurrency market with ease and efficiency, without the need to send their crypto to a centralised market, and without the risk of converting to an equally volatile asset.
With this in mind, stablecoins can also solve a number of issues beyond market volatility risk – as part of our development for AUDD, we explored a number of issues AUDD could resolve, including cross border remittance and international settlement.
Much like a traditional FX market, centralised and decentralised exchanges can create trading pairs between different stablecoins – and thanks to the functionalities of blockchains open source technology, development of products and services that interact with these markets allow for accessibility to new markets, demands, volumes, and revenue opportunities.
Further, domestic settlement, Arbitrage trading between cryptocurrency markets, travel rule compliance, and merchant payment facilitation (such as imports and exports), are also use cases that stablecoins innovate in.
Final Thoughts
Stablecoins and all of their kinds are still new to the cryptocurrency world. Although announced in 2018, it is gaining traction. Stablecoins have proved that they may facilitate a variety of challenges and stabilise the economy to some extent in many nations, and this is one of the primary causes for the rapid shift in the market. This includes the economic impact because of the COVID-19 outbreak.
Businesses and consumers may use stablecoins as an alternative to fiat currency more quickly if the sector can grow to its potential. The bulk of corporations are just waiting to see what happens, while a few have taken steps to ensure their assets comply with current rules. The introduction of stablecoins has made it easier to utilise virtual money to buy goods and services, but only time will tell if this will change the payment landscape in the long run.
