What Are Stablecoins?

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03.06.2021 13:52
What Are Stablecoins?

    Stablecoins are a type of digital asset with a stable price, independent from the cryptocurrency market fluctuations. The price stabilization is reached by various methods:

    1.       Stablecoin providers create fiat currency reserves to provide stablecoins liquidity.
    2.       Special smart contracts are created to ensure fiat currency exchange.
    3.       Special price stabilization algorithms are applied.

    The easiest way to create stablecoins is to connect their exchange rate with the fiat currency price. Each stablecoin is equal to its real-money equivalent. The exchange ratio is 1:1. Fiat money is usually deposited in a bank to provide a fast exchange.

    Stablecoins pros and cons

    The most important advantages of a stablecoin backed by a real fiat currency are high stability and simplicity. Those stablecoins can be easily exchanged into fiat currency and vice versa as their liquidity is provided by fiat money.

    Stablecoins are used to conduct transactions worldwide. This helps to minimize transaction costs or to avoid sanctions. The main disadvantage of stablecoins is the centralization. Stablecoins backed with a fiat currency are created by a company, which has an obligation to provide fiat money for stablecoins. The trust towards the stablecoins is reached by various types of independent audits. Those measures allow stablecoin users to be sure the cryptocurrency is backed by real money and they are stored in a bank.

    The most popular stablecoins are backed by US Dollar, Japanese Yen, Euro, or British Pound. In other words, by the most popular world-leading currencies.

    When it comes to stablecoins backed by cryptocurrency, it is a more difficult process as compared to stablecoins backed by fiat money. Cryptocurrency reservation is done via a special smart contract. Those who create this type of stablecoins should reserve a certain amount of cryptocurrency (which is two times higher than the stablecoin’s price). If cryptocurrency's price goes down, the price of the stablecoin will remain stable due to these excessive cryptocurrency reserves. The smart contract eliminates stablecoin when its price falls below the minimum price.

    Stablecoins backed by cryptocurrencies do not need any bank depositary. Their stability and decentralization are the main features of those coins. As for the disadvantages, the stablecoin backed by a cryptocurrency will be eliminated once its price falls below a critical minimum.

    Stablecoins that are based on special price stabilization algorithms require no crypto or fiat currency reserves. The algorithm of currency stabilization is similar to those that central banks apply to control their currencies. Stablecoin is connected to a fiat currency rate. The algorithm follows the base currency price fluctuations.

    If the rate of the base currency goes down, the algorithm burns stablecoins. Otherwise, it issues new stablecoins to the turnover. The main disadvantage of this type of stablecoins is that they are dependent on the demand.

    Stablecoins became a very popular way to store currencies and to conduct transactions with them regardless of the rate stabilization mechanism that is used. When dealing with a stablecoin, you need to pay attention to the following aspects:

    1.       Regular audits and currency reserves.
    2.       Stablecoin system stability.
    3.       Stablecoin liquidity and risks.

    What to know before investing into stablecoins

    Broex trading platform offers various stablecoins including Tether, USD Coin, BUSD, and Paxos Standard. Tether is backed by USD currency reserves that are deposited on the Tether Limited account. The market capitalization is $59 842 173 723 (by May 24, 2021)< market rate is 35 302 USDT = 1BTC. Tether ranks fourth according to the CoinMarketCap.

    USD Coin is backed by USD. This project was developed by the famous cryptocurrency exchange Binance in cooperation with Circle crypto-financial company. The market capitalization of USD Coin is $14 394 779 741. USD Coin's current market rate is 35 386 USDC = 1BTC. This stablecoin ranks 10th according to the CoinMarketCap.

    Binance USD is another stablecoin designed by Binance cryptocurrency. It was launched in cooperation with Paxos. It is used as a digital US Dollar on the cryptocurrency exchange. Paxos is responsible for BUSD backing. The market capitalization of BUSD is $8 617 194 665. Current market rate is 35 474 BUSD = 1BTC. It ranks 16th according to the CoinMarketCap.

    Paxos Standard is another USD-backed stablecoin designed by the Paxos trust company. PAX market capitalization is $1 399 225 796. 1BTC = 35 292 PAX. It occupies 58th position on the CoinMarketCap website.

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