Stablecoins: A Simple Guide For Beginners

You have probably heard about USDT and other fiat-pegged cryptocurrencies, or even have some in your portfolio. Those are stablecoins, a highly popular digital asset that is also held in high esteem within regulators.

Here’s everything you need to know about these special coins.

What are stablecoins?

Stablecoins are a type of cryptocurrency that serve as a bridge between digital money and real-world assets. Typically, stablecoins should be pegged one-to-one and hold their value with underlying fiat currencies like the US dollar, euro, yen, etc. Fiat money is expected to be kept on banking accounts of the issuing firms.

What stablecoins are there?

There are many different types of stablecoins in the market with the respective backing of their underlying fiat currencies or commodities — hard physical assets such as gold or silver. 

However, there are also crypto-collateralized, or algorithmic stablecoins like Maker’s DAI. Let’s explore them all.

Fiat-backed coins

This type of stablecoins is backed by and relies on a one-to-one ratio with its corresponding fiat currencies. The examples are Tether USDT and Circle USDC. They are the most popular stablecoins nowadays, and the largest players by market capitalization with $66 billion and $55 billion respectively.

To ensure the proper performance, fiat-pegged stablecoins must be thoroughly backed and transparently audited by trusted third parties. 

Commodity-backed stablecoins

These stablecoins are backed by physical assets such as precious metals — certified gold or silver reserves. Some less popular coins are pegged by commodities, for example, crude oil or natural gas. Still, metals-backed cryptocurrencies are among the top-ranking ones, with Tether Gold (XAUT) and DigixGlobal (DGX) heading the list.

Algorithmic stablecoins

The most decentralized type of stablecoins, algorithmic, is considered to be the most trustworthy by many advanced crypto users. Algorithmic stablecoins focus on improving market price stability through pre-programmed supply for matching asset demand.

They are backed by other cryptocurrencies, and smart contracts on the Ethereum blockchain automatically stabilize their value.

Maker’s DAI is thought to be the most trusted decentralized stablecoin. It runs on Ethereum and aims to support a value of $1.00. Unlike fiat-pegged centralized stablecoins, DAI isn’t backed by US dollar reserves.

Stablecoins and governments

Surprisingly, the idea of connecting real-world currencies to their blockchain-based analogues has been welcomed in many countries. The most recent example is the UK, which upgraded its regulation toward stablecoins. They now are ‘digital settlement assets’, which means they have potential to develop into a widespread means of payment.

In the US, the regulatory landscape for stablecoins is marked with uncertainty. However, stablecoins as a technology have achieved significant success, especially in the banking sector.

Meanwhile, in the EU stablecoins are still neither prohibited, nor regulated. Only Switzerland and Malta have built a friendly environment for their circulation.

Are stablecoins safe to invest in?

Normally, stablecoins maintain their pegged value and are less susceptible to volatility than cryptocurrencies like Bitcoin and Ethereum. The issuing firm should guarantee it by keeping each user’s coin in fiat equivalent on its banking account.

Unfortunately, there were cases where stablecoins failed to maintain their value because of hacks and liquidity issues. 

For instance, once-popular algorithmic stablecoin terraUSD (UST), which was supposed to maintain a $1 price, fell to $0.35 in May 2022. Its companion token LUNA, meant to stabilize UST’s price, also collapsed to a few cents. That happened because $2 billion worth of UST appeared to be unstaked (taken off the blockchain protocol), leading to liquidation of coins.

So, how to use stablecoins?

By definition, stablecoins can’t grow in price with time, unlike typical cryptocurrencies. But they can be a good option if you want to protect your fiat money from inflation by purchasing digital US dollars.

Another great use case is trading stablecoins in pairs with other cryptocurrencies on exchanges. Typically, crypto/crypto pairs (e.g. USDT/BTC) are charged with less fees than fiat/crypto trading pairs (euro/BTC). 

And the last, but not the least reason to invest in stablecoins is faster and cheaper P2P transactions. Indeed, sending money to another person via crypto wallet can save much time and dollars, compared to bank transfers.