Stablecoins: Types, Use Cases, and Benefits
If you were to ask why conventional cryptocurrencies such as Bitcoin still suffer in terms of credibility, you would probably hear about their volatility. They are notorious for oscillating between a bullish high and a bearish slump, and this fluctuating value has lead Bitcoin's early adopters such as Microsoft to withdraw support. To help solve this, stablecoins emerged. Here we shall cover types, use cases and benefits of stablecoins.
Let's dig in.
What are Stablecoins?
Stablecoins are cryptocurrencies pegged to stable assets like fiat currency and gold. Currently, the most popular option for a stable asset is fiat currency.
Stablecoins are designed to tackle the high volatility in the crypto market. Unlike traditional cryptocurrencies, stablecoins allow for secure and convenient transactions without high volatility.
Different Stablecoins Types
There are several types of stablecoins. They include:
• Fiat-Backed Stablecoins
Fait-backed stablecoins are coins that are fully backed by fiat currency. The idea is for every stablecoin there is real fiat currency in physical bank accounts. This means one unit of stablecoin is equivalent, for example, to $1.
This type of stablecoin receives a lot of criticism due to its centralised nature. It creates the need for third-party involvement. To some crypto advocates, this system defeats the whole purpose of a trustless, decentralised system introduced by blockchain tech.
This type of stablecoin works by depositing your fiat currency into a bank, broker or exchange associated with the stablecoin. The network then "creates" new coins. When you want to redeem cash with your stablecoins, the system will burn your coins and give you fiat.
Example of a fiat-backed stablecoin
Tether is the most dominant and popular stablecoin in the crypto market. It is backed by the US dollar and issued by Tether Limited, a company with close links to Bitifinex exchange. Tether (USDT) offers crypto traders a way out of traditional cryptocurrencies. It has a market capitalisation of over $2 billion.
• Cryptocurrency-Backed Stablecoins
Cryptocurrencies back Cryptocurrency-backed stablecoins (as the name suggests). The cryptocurrencies are usually several types for better risk distribution. The highly-ranked cryptocurrencies like Ethereum and Bitcoin with large market capitalisation are often preferred.
The volatile nature of cryptocurrencies makes it had to rely on a single cryptocurrency as a store of value. This is why it necessary to back stablecoins with a mix of cryptocurrencies.
Cryptocurrency-backed stablecoins are often over collateralised to avoid liquidity problems in times of extreme price fluctuation of crypto.
Example of cryptocurrency-backed stablecoin
MakerDAO is the company behind the Dai stablecoin and Makercoin, a token with a volatile price. Makercoins buy services on the Maker Platform. To interact with the Maker system, you will first have to create a collateralised debt position. Learn more about Maker and Dai in this whitepaper.
• Asset-Backed Stablecoins
Asset-backed stablecoins include those backed with a single asset or a basket of assets. The most common asset used to support stablecoins is gold. Many view gold as a good store of value. Some stablecoins are backed by oil like the Petro Coin supported by Venezuela's oil reserves.
While asset-backed stablecoins are not as popular as fiat-backed stablecoins, they do provide an alternative avenue for people looking to transact in tokens backed by tangible assets like gold.
Example of Asset-backed Stablecoins
DIGIX GOLD TOKENS (DGX)
DGX, created by DigixGlobal, is one of two tokens generated by the Digix team. The second token is DigixDAO, which is used for governance.
The DGX token is backed by a physical token stored in a vault in Singapore. The DGX token is fully redeemable whenever a user wants. DGX utilises the Ethereum blockchain to secure each gold bar and track its ownership status.
Before we delve into use cases, you may want to review the advantages and disadvantages of each type of stablecoin here.
Use Case of Stablecoins
Stablecoins are an excellent option for trade. With less volatility than traditional crypto coins, stablecoins offer traders a more stable environment.
Tether, the world's largest stablecoin by market cap, is already dominating the crypto space. The stablecoin was used in 40 per cent of the transactions on Binance and 80 per cent on Huobi.
Stablecoins are useful as a means of payment in stores and other services. With stablecoins businesses get to circumvent the transaction fees that come with intermediary services. Blockchain offers trustless transactions that are cheaper, faster, and efficient.
Walmart has already unveiled a patent of its own stablecoin, which has payment as one of its use cases. Walmart is not the only one. Many other businesses are looking to utilise stablecoins as a payment option.
Stablecoins can also be used to pay workers. International workers can quickly get paid and send money home without paying high foreign transaction fees. Sea fearers and oil drillers in the middle of the ocean don't have to wait till they reach land to get paid.
In 2018 a Japanese shipping company (Nippon Yusen Kaisha) made headlines in the crypto space by introducing plans to pay workers with USD-pegged stablecoins.
Stablecoins add automation to escrow services making transactions faster, secure, and efficient. By utilising blockchain and smart contracts, stablecoins eliminate the need for intermediaries in escrow services. Without intermediaries, transaction fees go down, and speeds do higher.
Benefits of Stablecoins
• Faster transactional speeds
By utilising the blockchain and smart contracts, stablecoins can cut out intermediaries and increase transactional rates. Escrow services can get faster and more efficient. Because the blockchain is autonomous, one can conduct transactions even at odd hours.
• Lower fees
Stablecoins can significantly reduce high charges that come with intermediary services. People working abroad can send money home without having to incur high international charges. Lower costs can increase more usage of platforms, possibly boosting scalability.
Stablecoins introduce transparency to services with minimal to no transparency. Transparency promotes accountability, which improves trust in businesses and institutions. By utilising the blockchain stablecoins ensure any transaction is noticeable by all users in the network.
Stablecoins are tradeable anywhere in the globe and at any time. The blockchain makes stablecoins readily available and accessible around the world. Unlike fiat currency limited by borderlines, stablecoins have no border restrictions.
• Secure transactions
Blockchain makes stablecoins safe and tamperproof. Thieves have no way of accessing digital coins, no matter how hard they try. And, with stablecoins, you have direct transactions in play without the fear and worry of fraudulent activities.
Stablecoins seems to be the key to scalability when it comes to cryptocurrencies and blockchain. Their reliance on physical assets for value makes them highly reliable compared to traditional cryptocurrencies.
Companies like MakerDAO and Tether have proven there is a need for stablecoins. Since their introduction to the market, demand for Stablecoins continues to increase. Their less volatile nature makes them excellent alternatives to traditional cryptocurrencies. Finally, while they are still in their infancy stages, stablecoins seem to be taking blockchain and other cryptocurrencies in the right direction.
About the author:
Jay Jackson is a blockchain enthusiast and a freelance writer at topcryptowriter.com. He works closely with brands (people, businesses and startups) in the crypto sphere. He currently writes Blog posts, Guides, Press releases, ICO reviews, eBooks & Whitepapers. You can find him on LinkedIn.
The above references an opinion and is for informational purposes only. Do not take this as personalised financial advice or investment advice. The views expressed by the author do not necessarily represent the opinion of BitPrime.
Last updated: 10/02/2020