Stablecoins may prove to be a great route to drive digital coins and tokens to the mainstream financial system.
What Is a Stablecoin?
A stablecoin is a term that is coined for cryptocurrencies that offer its buyers a combination of the best of both – the cryptocurrency and the fiat currency. Just like Fiat currency, a stable coin is not volatile and is supported by a reserve asset. And in terms of its comparison with cryptocurrency, stable coins come with features like instant transfers, high level security and privacy at an affordable price.
If you are a Crypto enthusiast, you have already witnessed the highs and lows of Bitcoin. Bitcoin, the first cryptocoin which came to limelight in the last decade has seen an exponential growth since then. The journey of Bitcoin which started from 0 has soared till 65000 US dollars before reaching the mark of 40,000 US dollars at which it is traded today. If a currency is this volatile, it will fail to build the trust among its long term investors.
Apart from this, the daily speculations in BTC are sometimes beyond imagination. Thus extremely volatile nature of the cryptocoins impart them a risk of a very high degree. These kind of loss may be unbearable for general public. This potential risk is, what is taken care of by a stable coin. Hence they provide a hedge against the volatility shown by digital currencies.
Stablecoins, therefore keep themselves stable by pegging their value to some external source of reference. This backing can be in various forms like a fiat currency, a commodity or other digital currency etc. Stablecoins plugins the loop holes of both the cryptocurrency and the fiat currency.
Types of Stablecoins
Stablecoins can be broadly classified into three types on the basis of the collaterals they are pegged to.
Fiat-Collateralized Stablecoins
A Fiat-collateralized stablecoin is pegged to a fiat currency like the pound or the U.S. dollar. For issuing a particular amount of Cryptocoins, the issuing company needs to keep an equal amount of sovereign currency as security. Apart from fiat currency, precious metals or other commodities can also be used as collateral. Precious metals can include metals like gold and silver whereas commodities can include oil, etc. Among all the collaterals, US dollar is the most popular mode.
Independent custodians take the charge of maintaining the reserves. They are also audited from time to time to keep a tab on the adherence to rules and regulations.
Tether (USDT) and TrueUSD are the most sought for crypto coins that are backed by US dollar reserves. Both the tokens exist on Ethereum blockchain.
Their original value is worth US$ 1, which implies that they have to maintain a reserve of $1.00 for each cryptocoin issued by them. The amount to be reserved as a fiat collateral is generally placed under the custody of banks and therefore are not a part of smart contracts. Tokens can be bought and sold for US dollars anytime.
Crypto-Collateralized Stablecoins
As the name suggests, Crypto-collateralized stablecoins are secured by other cryptocurrencies like Ether, etc. The important point to be noted here is that the collateral itself is as volatile as the stablecoin. Due to this reason the stablecoins using cryptocurrency as their security need to maintain reserve in a much higher number as compared to the coins issued by the concerned company. In technical terms, this mechanism is also referred to as ‘over collateralization’.
In case of crypto-collateralized stablecoin, the reserve collateral tokens are locked in a smart contract. The collateral can be redeemed by paying stablecoins back into the smart contract.
DAI is one of the most popular crypto backed stablecoin by MakerDAO. It uses smart contract technology on Ethereum blockchain to gain stability. Likewise, The EOSDT token lives on the EOSIO blockchain and also keeps a check on the price of USD. This token uses both EOS and BTC collateral to strengthen its position in the market.
Non-Collateralized or Algorithmic Stablecoins
Algorithmic stablecoins are novice in the field and are still in emerging mode. Non-collateralized stablecoins are not pegged to any currency or commodity- real or virtual, rather their value is decided by an automated mechanism executed through smart contracts. It not only helps in managing the supply of tokens but also keep a check on volatility.
Such actions are similar to a central bank printing banknotes to maintain valuations of the fiat currency. It can be achieved by implementing a smart contract on a decentralized platform that can run in an autonomous manner.
Can Stablecoin be the replacement for Cryptocoin?
It is too early to draw any conclusions regarding the future of the stablecoins. To a common man, they may seem to be a perfect investment zone but the governments across the world may not be of the same opinion. How the governments might perceive it as unhealthy is a matter of concern.
In case of fiat-collateralized stablecoins, the most conventional choice for the reserve is US dollar. This may be in the better interests of US but may lower down the value of currency of other nations. The investors may convert their native currency to US dollar for ease of trade.
Therefore in order to be the future of cryptocurrency, stablecoins will require some modifications as well as regulations.
