Stable Coins – Catalyst to Cryptocurrency
Stable coins are a type of cryptocurrency is pegged to maintain a stable value relative to a specific asset, such as the US dollar. The value of a stable coin is pegged to the value of the underlying asset at a 1:1 ratio, which means that one unit of the stable coin is equivalent to one unit of the stable asset. It’s designed to reduce the price volatility that is commonly associated with cryptocurrencies. It is a currency that is global but is not tied to any central bank and has low volatility. This makes it possible for day-to-day exchange.
An optimal Cryptocurrency should have the following four traits:
- Price stability.
Short-term stability is important for transactions and long-term stability is important for holding. The adoption of stable coins will be a catalyst to the new decentralized internet becoming mainstream.
Examples: USDT, USDC, DAI, and TUSD.
Why Do We Need Stable Coins?
We’ve got Bitcoin, Ethereum, etc., then what is the need for a new kind of coin? The thing is Bitcoin, Ethereum are too volatile and hence these coins are not a reliable store of value. Each day the value of these coins changes and that makes usage of these cryptocurrencies difficult for a day to day transactions. Imagine paying 10$ for a Data Structures course and realizing tomorrow that it only costs 9$. So is there a solution? Stable Coin is a solution to such problems.
What are the different types Of Stable Coins?
There are four different models of Stablecoins:
- Fiat collateralized: Fiat collateralized is the simplest solution. One such coin is Tether. The idea is to get a Tether for each dollar you spend. Therefore, there is a bank account that stores the dollar, and Tether is issued based upon that. Other coins that are 100% backed by fiat collateralized reserves are USDC which is run by Circle, Candy backed by Mongolian currency.
- Real asset collateralized: DGX is a cryptocurrency that is collateralized with Gold. One DGX equals One gram of Gold. They use the Ethereum ERC-20 protocol. There is a vault in Singapore that stores Gold and is audited every three months. There’s also an additional fee that you need to pay which goes in the maintenance of the vault(security, maintenance, etc) and other exchange fees. Tiberius coin is another stablecoin that is backed by seven metals that are linked to technology.
- Crypto collateralized: For the first two models of stable coins one needs to have a vault or storage where you store the asset. However, in this model, the asset is itself digital. So there is no additional cost for the security and maintenance of the vault. The stability is maintained through an autonomous system of smart contracts. A famous example of this type of stable coin is Dai.
- Non-collateralized: This model of stable coins is very complex. This model implements the idea of dynamic monetary policy to stabilize the crypto value. Value is maintained by supply and demand through algorithms. The basic idea is as the price increases, more coin is created and as the price decreases, the coin is purchased to decrease the supply. The basis is one such example of this type of stable coin.
Advantages of Stable Coins:
- The value of stable coins remains more or less the same since they are pegged to other assets like Gold, US Dollar.
- Stable coins can be used for day to day transactions with the added advantage of transparency, privacy given by a cryptocurrency.
- During a period of hyperinflation, stable coins help people maintain the value of their dropping currency.
- Smart contracts act as a cherry on the cake in the use of stable coins. Different smart contracts can be set up between the exchanging authorities to automate the process of exchanging stable coins without any extra cost.
- Stable coins are mostly used in DeFi applications, such as lending and borrowing.
Limitations of Stable coins:
- Fiat collateralized and Real collateralized coins require an added cost of maintaining the vault which stores the asset and this cost can be high.
- Although stable coins are designed to maintain stability, they are not immune to market volatility and may experience fluctuations in value.
- Stable coins may face regulatory hurdles as they are still a relatively new concept. Regular audits are required to check the transparency and reserves of the organization issuing the coins, which in itself is a burden.
- Stable coins may face liquidity issues in case of a sudden surge in demand, leading to a decrease in the value of the stable coin.
- Countries do not yet have the infrastructure for the exchange of Stable coins and some of the countries have even made the exchange of cryptocurrency illegal.
- Non-collateralized stable coins come with different sets of limitations, they are complex to understand and people generally do not prefer to go from a simpler (current system of exchange) mode of exchange to a complex (stable coins system of exchange) mode of exchange.
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