A Beginners Guide To Stablecoins In Cryptocurrency

The world of cryptocurrency is expanding by leaps and bounds with each passing day. Either there are new currencies coming into existence or the existing ones are going through technological changes and advancements. Being an active part of the crypto world has various benefits, financial and otherwise. The current value of all the cryptocurrencies in the market is roughly around 3 trillion dollars, marking a major shift in the way people trade and invest. Everyone is familiar with cryptocurrencies and how they function, especially the widely known cryptos like bitcoin, ethereum, tether etc. Bitcoin, being the oldest cryptocurrency, has become famous all over the world and is currently valued at approximately $35,000, having faced a slight downfall recently. You can check out the bitcoin price in India to get a fair idea of its value. While everyone has a basic idea of the cryptomarket, there are certain niches that might prove to be confusing for newbies in the crypto world. One of those is Stablecoins. 

What is Stablecoin? 

By definition, stablecoins are a class of cryptocurrencies that attempt to offer price stability and are backed by a reserve asset, such as gold or U.S Dollar. Stablecoins have gained traction as they attempt to offer the best of both worlds, the instant processing and security or privacy of payments of cryptocurrencies, and the volatility-free stable valuations of fiat currencies. Stablecoins, as their names suggest, are stable. They do not have the volatility of the cryptocurrency yet have the purchasing power that most cryptos have. One of the most sought after stablecoin is Tether. Tether is the undisputed leader among stablecoins with a market cap of about $75 Billion. It is a decentralized cryptocurrency that tracks the prices of fiat money like the rupee or dollar and offsets the fluctuations in the price of the cryptocurrency. Tether is represented by USDT and like all other stablecoins is pegged to actual assets. The value of USDT to INR is approximately 74 rupees as Tether is pegged to the US Dollar, maintaining a 1:1 ratio. 

Types Of Stablecoins

There are three main types of Stablecoins in circulation, fiat-collateralized stablecoins, crypto-collateralized stablecoins and algorithmic stablecoins. Let’s take a deep dive into understanding these. 

  • Fiat-Collateralized Stablecoins : 

A great example of fiat-collateralized stablecoins is Tether. These stablecoins maintain a fiat currency reserve as collateral, in other words, they are backed by sovereign currency such as the pound or the US dollar. They issue a certain number of tokens to a given cryptocurrency and in return the issuer must offer dollar reserves worth the same amount as collateral. Other forms of collateral can include precious metals like gold or silver as well as commodities like oil. These reserves are regularly maintained and audited in adherence to necessary compliances. Tether and TrueUSD are some of the most popular fiat collateralized stablecoins presently.

  • Crypto-Collateralized Stablecoins :

Stablecoins that are backed by other cryptocurrencies instead of fiat currency are known as crypto collateralized stablecoins. Since their reserve cryptocurrency may be prone to high volatility, these stablecoins are over collateralized, meaning that a large number of cryptocurrency tokens are issued to maintain a lower number of stablecoins. For example, $2,000 worth of bitcoin might be held as reserves to issue $1,000 worth of stablecoins. This is done to accommodate nearly 50% fluctuation in reserve currency and requires far more frequent auditing and monitoring to lend price stability. An example of crypto-collateralized stablecoin is MakerDAO’s DAI, which is generated, backed and kept stable by the use of Ethereum based currency deposited into MakerDAO’s vaults. Even though it is slightly more volatile than fiat backed stablecoins, it is still relatively low risk. 

  • Algorithmic Stablecoins :

Instead of using a reserve, non-collateralized stablecoins operate on a working mechanism, like that of a central bank, to retain a stable price. They do not have any associated collateral and use a consensus mechanism to increase or decrease the supply of tokens based on market needs making their functionality similar to that of central banks which print banknotes to maintain valuations of the fiat currency. This is achieved by implementing a smart contract on a decentralized platform and having it run in an autonomous manner. Offering a higher price stability, algorithmic stablecoins have a considerably improved capital efficiency. 

How are Stablecoins Regulated? 

Stablecoins make up for a $130 billion market. Naturally these come under scrutiny of regulators due to their size and potential impact on the financial market. It is demanded that stablecoins should be regulated as financial market infrastructure alongside payment systems and clearinghouses. It has been proposed by various financial institutions and politicians that targeting specific stablecoins that are deemed systemically important and have the ability to disrupt payment and settlement transactions, will be the best way to regulate stablecoins. Although there has been constant talk of stablecoin regulation, a final verdict on their regulation is yet to come. 

 

Janet Brown