What Are Stablecoins and Top Picks?

Summary Asset prices in cryptocurrencies like Ethereum and Bitcoin are entirely determined by market supply and demand. These coins are not recognized as official state currency and are not regulated by a centralized agency, hence their value is subject to change.

Stablecoins have been developed, though, and offer a safe way out of this instability. For a more thorough understanding of stablecoins, let's dive into the blog.

An Introduction to Stablecoins As the name suggests, a stablecoin is any cryptocurrency that maintains a steady value relative to conventional monetary assets. Stablecoin's value is supported by low-risk assets like gold or fiat money, which lowers price volatility. A single fiat currency, a group of currencies, or other priceless assets might serve as its backing.

Stablecoins seek to mitigate the volatile nature of digital assets by fostering a more dependable and stable environment that promotes the use of digital currency. They combine the stability of fiat currencies with the security and decentralization of cryptocurrencies to provide you the greatest possible balance.

The rise of Stablecoins BitUSD, which debuted in 2014, is recognized as the first stablecoin in the cryptocurrency space. These assets were created to strike a compromise between the decentralization, speed, and security of cryptocurrencies and the stability of fiat money in the real world.

Since then, several more stablecoins have been created, employing different techniques to maintain their value. Because they are backed by a reserve of fiat currencies, such as the US dollar, euro, or Japanese yen, the majority of stablecoins are fiat-collateralized.

Since more stablecoins were created to meet the growing demand for stable assets on the cryptocurrency market, the use of stablecoins expanded as a result of the DeFi market's success in 2020 and 2021. Stablecoins protect customers against price inflation and financial eviction in addition to offering a safe and secure monetary system for investors and users to conduct routine activities.

Stablecoins are one of the few token classes that have maintained market capitalization since its inception, both in booming and collapsing markets, despite the sharp swings of more well-known cryptocurrencies like Bitcoin and Ethereum.

The majority of cryptocurrencies can link in terms of market capitalization. Stablecoins differ from the majority of cryptocurrencies, though. The very steady market capitalization of stablecoins may indicate that the majority of users aren't trading them in for cash. It is more probable that stablecoins will continue to exist inside the bitcoin ecosystem.

How does Stablecoins work? Simply explained, a dollar or the currency to which its coin is tethered is deposited for every stablecoin that is put into circulation by an exchange that provides a fiat-backed stablecoin. Stablecoins are therefore linked to that currency, and its owners may theoretically exchange them for fiat money at a 1:1 ratio. Although the majority of market value is made up of fiat-backed stablecoins, active stablecoins are linked to other assets.

What are the different types of Stablecoins? The varieties of stablecoins differ in the support they have from various assets; the most frequent forms are fiat-backed stablecoins, commodities-backed stablecoins and algorithmic-backed stablecoins. Let us now analyze these three types in depth for better understanding:

Fiat currencies Backed Stablecoins The first and most popular strategy is to support every stablecoin in circulation to the same extent using fiat money or cash equivalents. Supporting a token with an equivalent quantity of reserves held in a bank account is the simplest way to link its value to the US dollar. It shows that one USD is kept in reserve in the issuer's U.S. bank accounts for every stablecoin in use. Users can deposit one dollar for the equal quantity of tokens from the issuing company.

However, users may always convert their tokens into cash. This convertibility adds to the stability of the stablecoin since it makes it possible to purchase and economically redeem tokens that trade for less than $1. As the "buyer of last resort," the issuer backstops the token using the value it has increased. But because it relies on the financial system and an issuing company, this idea is very centralized.

Algorithmic Backed Stablecoins Algorithmic stablecoins are designed to provide a decentralized approach that follows the dollar through a variety of procedures both inside and outside the chain. They may not be backed by other assets, or they may use a fractional reserve concept. Algorithmic currencies are extremely risky to invest in, and numerous well-known ones have failed (Terra being the most recent). None so far have proven stable and dependable enough to be generally embraced.

The third and last strategy to maintain a stablecoin's peg is to use smart contracts, which are algorithms that automatically run to adjust the circulating supply based on market circumstance. The smart contract limit restricts how much cryptocurrency is in circulation when the value of algorithmically backed coin drops. When a price begins to move over the peg, the smart contract increases the quantity in circulation to preserve price stability.

Commodity backed stablecoins Commodity-backed stablecoins are backed by changeable assets, such precious metals, as opposed to algorithmic stablecoins. The item most frequently used to underpin these stablecoins is gold. Some stablecoin issuers, like Kitco Gold and Daxos Gold, want to use gold bars to cash out their currencies.

But occasionally, assets like real estate, oil, or other precious metals are used to support stablecoins. Often, the item under protection is stored in a vault that is held by a trustworthy third party. Stablecoin buyers have the option to trade their coins for goods or services.

Crypto-backed Stablecoins Another similar strategy for maintaining a stablecoin's price peg is crypto-collateralization, which involves using assets of other cryptocurrencies to support stablecoins. Since cryptocurrencies are far more volatile than conventional money, crypto-backed stablecoins are usually overcollateralized.

A 1.5x guarantee in Ethereum (ETH) or other cryptocurrencies equivalent to the corresponding value of each DAI in circulation is provided by MakerDAO's Dai (DAI) stablecoin, for instance, which is collateralized at 150%.

Where to Store the Stablecoins? Steady coins can be stored on an exchange or transferred to a cryptocurrency wallet. In the former scenario, you do not actually own the stablecoin; it is held "in custody" by the platform. Until you transfer the stablecoins from the exchange into a "self-custody" wallet, you do not actually own them.

Every option has benefits and drawbacks. It's handy to store stablecoins on an exchange, especially if you trade regularly. But there's some danger in that. Exchanges may encounter hacking or commercial collapse. Because they are exempt from rules, clients may have limited alternatives.

Because of this, a lot of stablecoin owners choose to store their coins in private wallets. These consist of "hard" wallet drives, which resemble USB sticks with digital controllers, and software-based digital "soft" wallets.

What is the application of Stablecoins? Below given are the main applications of Stablecoins:

Money transfers They provide a quick and easy method of sending money abroad without having to comply with strict government regulations or make major changes to banking institutions.

Trading Stablecoins give traders and investors a safe location to keep their money while enabling them to enter and exit positions swiftly. In this sense, stablecoins serve as a hedging mechanism against market fluctuations.

E-com payments They provide a more reliable and secure way for businesses and individuals to make payments online than fiat currencies, which are susceptible to inflation, and volatile cryptocurrencies.

DeFi applications Stablecoins are a key component of the DeFi ecosystem. They provide a straightforward and secure entry point for novices to participate in decentralized financial operations like as farming, staking, lending, and borrowing.

Which are the Top Stablecoin Tokens? The list of top Stablecoins includes Tether, USDCoin, Binance Dollar, Dail and TrueUSD.

Tether(USDT) The first stablecoin introduced in 2014 that had significant popularity in the cryptocurrency industry was Tether (USDT). The Hong Kong-based issuing company, which has varying degrees of convertibility, backs each USDT 1:1 with cash or currency equivalents. With a supply of over 104.4 billion USD and significant daily trading volumes, Tether is the most widely used stablecoin according to current statistics. It is supported by several exchanges.

USD Coin (USDC) USD Coin (USDC) is a stablecoin that represents tokenized US dollars on the Ethereum (ETH) network. Coinbase and Circle created the center group that runs it.

Dai (DAI) Dai (DAI), a cryptocurrency on the Ethereum (ETH) network, is maintained by MakerDAO, a decentralized autonomous organization, or DAO. One of the earliest examples of decentralized finance (DeFi) becoming widely accepted was Dai.

First Digital USD(FDUSD) First Digital Labs, a separate Hong Kong-based business, distributes First Digital USD (FDUSD), a stablecoin with a 1:1 USD backing.

FDUSD offers customers a stable digital currency that seeks to increase the effectiveness of financial transactions by reducing volatility in the cryptocurrency market by lowering transaction fees and enabling quicker, more secure transactions.

Financial contracts, insurance, financial services, and a programmable stablecoin may all be conducted with FDUSD's assistance without the need for middlemen.

Ethena (USDe) In February 2024, Ethena Labs introduced Ethena USDe, a synthetic dollar. Because it is based on the Ethereum protocol, it is known as Ethena UDSe.

The USDe has an infinite supply, is stable, and is impervious to censorship. Unlike other stablecoins, it depends on the 1:1 backing but does not totally rely on collateralization. Because it is less volatile, it may be utilized for regular investing.

What are the Pros and Cons of Stablecoins? Stablecoins, like any other asset, also have their own set of pros and cons; these are as follows:

Pros of Stablecoins 1-Digital Assets The main benefit of stablecoins over fiat money is its use of blockchain technology, which makes it possible for them to conduct international transactions more quickly and cheaply. These currencies' short settlement times make them excellent tools for international trade. They are also easy to use because they operate from wallets in a manner similar to that of traditional cryptocurrencies.

2-Absolute Volatility Blockchain technology makes stablecoins more dependable, which is essential for boosting their acceptability. They frequently avoid moments of extreme trading volatility since they are backed by commodities or fiat money.

3-Protection Against Falling Markets Stablecoins have become more and more popular among traders who want to hedge against other cryptocurrencies when their prices decline. Stablecoins allow dealers to quickly sell their digital assets and return to the market as soon as the price stabilizes.

Cons of Stablecoins 1-Centralization Although cryptocurrencies and blockchain technology embrace the concept of decentralization, stablecoins offer a centralized aspect, particularly with the asset backing. A team that leans the operation farther toward a centralized structure is required to ensure that each currency in circulation is supported by an equivalent reserve value.

2-Transparency Many stablecoins have lost the trust of the public and require greater transparency. For example, Tether has been the subject of public controversy over its reserve levels, leading to penalties and restrictions from the U.S. government. Since then, the company has been publishing reports on its reserve holdings.

What are the risks and challenges involved in Stablecoins? king down the 1:1 peg One significant structural risk associated with stablecoins is the possibility that they would deviate from their 1:1 peg to underlying fiat currencies or other reserves. It is essential to have a high degree of trust in the third parties that own and manage the pertinent reserve assets. To make sure that the appropriate quantities of collateral are kept, external audits are necessary, but they may be expensive and time-consuming.

Regulatory Risk One of the biggest risks associated with stablecoins is regulatory risk. Because stablecoins are often linked to fiat money or other assets, they may fall under regulatory frameworks. Additionally, certain stablecoins may be categorized as securities by regulatory bodies, which might result in legal problems.

Market Risks One of the primary hazards associated with stablecoins is the market. Due to their reliance on other assets, stablecoins are susceptible to market fluctuations. Using the US currency as an example, if a stablecoin is tied to the US dollar and the US dollar's value declines significantly, the stablecoin may likewise lose value.

Liquidity risk if a large number of stablecoin owners choose to instantly swap their coins for the basic asset. The stablecoin's value might drop in that scenario if the issuer does not have enough liquidity to meet demand.

What is the difference between Stablecoins and Cryptocurrency? Stablecoin is also a crypto form, but it varies from cryptocurrencies in many aspects. Let’s know which are the factors that distinguish stablecoins from cryptocurrency:

Current analysis of stablecoins There are more uses for stablecoins than just financial transactions. It is the creation of shaky cryptocurrencies and well-known payment mechanisms. Additionally, it offers financial benefits on par with conventional currencies.

According to latest data released by Coingecko, the market capitalization of stablecoins has risen to $134,896,961,867, with Tether controlling the bulk of the market. As a result, it illustrates the erratic character and popularity of stablecoins, which will only continue to increase in consistency.

Future of Stablecoins Because they are reliable assets, stablecoins might lead to a significant increase in the use of digital assets in everyday life.

There has been a significant change in stablecoins between 2021 and 2023. Even as the market fell from $3 trillion to $1 trillion, the stability of stablecoins' market value demonstrated their capacity to remain secure despite the erratic nature of cryptocurrencies. Prominent stablecoins like USDC and USDT held onto their positions.

The rapid expansion and variety of the stablecoin market are proof of the continuous innovation in the cryptocurrency market. Since stablecoins are only a modified form of money, it is anticipated that the government would regulate them in tandem with their rise.