Cryptocurrency Finance

What is Stablecoin? Types of Stablecoin and Uses

I have been writing about blockchain and crypto for a while now. Every time I push the agenda of jumping into cryptoverse, I definitely get this from my beloved normies (someone who doesn’t invest in crypto): Raghav, it’s very volatile. And they aren’t wrong either. In my active investing journey of crypto, my portfolio has fallen up to 70% and still positive after all this. Cryptocurrencies are indeed a risky and volatile asset class. But what if there was a type of crypto that was as stable as a US dollar? Well, there actually is, and it is called a Stablecoin. Today, we would jump into nitty gritty of a Stablecoin. What is Stablecoin, what are it’s types and key uses. We would also touch upon some issues with using Stablecoins. Let’s jump right in:

What is Stablecoin?

Well, it’s no rocket science to guess this at this juncture. Think of it as a crypto version of fiat money. A cryptocurrency that is pegged to an asset such that it’s price always mimics a USD is called a stablecoin. This means that 1 unit of a specific stablecoin would always be equal to 1 USD (or whatever currency it is pegged to). Technically, it is a utility token built upon on another blockchain. The entire aim of creating a stablecoin is to create a cryptocurrency that isn’t volatile and can leverage the benefits like security, privacy, speed and convenience of blockchain.

Key Uses of Stablecoin:

One might think that if it is just behaving as a US dollar bill would, why overcomplicate stuff and trade in it? One could always head towards forex markets to trade in currencies. Unlike crypto, these markets are regulated as well by a government body. Well, the answer is rather simple. This isn’t the only use case of stablecoins. Let’s explore each of these use cases:

A. Blockchain Store of Value:

One use case is rather simple and we just discussed it. Imagine if you want to store away some of your money in a completely decentralized, secure and private manner, crypto might be a very difficult option because of it’s volatility. Stablecoins help you solve this problem. Just like parking your idle funds in a bank account in India could fetch you ~3% APY, locking in your stablecoins can earn you up to 20% APY in some cases.

B. Easy Switching:

One can easily switch between cryptocurrency like Bitcoin, Ethereum and a stablecoin easily on a decentralized exchange. Imagine if there were no stablecoins. You would have to sell one of your crypto for fiat and then use that fiat money to buy the other crypto. Not to forget the costs associated with exchange fees and taxation because of this little switching venture.

C. Easy Entry in a Centralized Exchange:

I would talk about a couple of exchanges like WazirX and Binance here. Loading money into these exchanges is a very costly affair. Depending on the mode of payment use to load your wallet with INR, there is a varied fee. The image on the right shows various costs involved in loading money on the to the platform wallet on WazirX.

CoinDCX is currently running an offer wherein loading money using Mobikwik is free of cost but generally, they would also charge something for it.

Then comes trading in stablecoins using P2P. A pretty straightforward and free way of trading in cryptocurrency. All the payments happen outside the platform with centralized exchange acting as an escrow account and facilitating the transaction between two parties without charging anything.

And that’s what I have been doing for a while now. I buy USDT (a stablecoin) using INR through P2P and later use it to buy multiple cryptos.

How do Stablecoins Work?

There are two ways stablecoins are issued or minted in the market. Let’s explore each of them in detail:

A. Fiat Collateralized Stablecoin:

As the name suggests, this type of stablecoin has a physical asset backing up it’s number in the market. This physical asset is generally US dollar (1:1 ratio). In other cases, it could also be national currency of some other country like Euro, Won, Gold etc. Example of this type of stablecoin is Tether (USDT), USDC and BUSD.

B. Algorithmic Stablecoin:

Algorithmic stablecoins aren’t backed by any physical reserves. Rather, smart contracts govern their supply in such a manner that the value of 1 stablecoin is always equal to a dollar. One clear benefit of these type of stablecoins over the fiat collateralized counterparts is that they can easily be audited by reviewing the code. At the same time, you should understand that smart contracts can be extremely complicated and may have some bugs as well, this making the stablecoin, well, unstable?

The algorithm controlling the supply can be of multiple types and deserve a blogpost of their own.

Issues with Stablecoins:

Despite multiple benefits and acting as a bridge between CeFi and DeFi, stablecoins have their own set of issues which need to be addressed here:

A. Lack of Regulation/Overleverage:

Since companies like USDT are not yet regulated, there is a lot of concern around the fact if their holdings are pegged to USD in 1:1 ratio. There have been reports around USDT, the world’s largest stablecoin has been nothing more than a Ponzi scheme. So, if these reports were to be true, USDT can come falling down to zero. It might also bring the entire crypto market down with it due to it’s sheer influence.

B. Insurance:

There is a cash insurance available for fiat money in various forms. You can also insure physical/digital formats of your money. However, in crypto world, stablecoins have no such provision.

Recently, banks like PMS bank and Yes bank declared bankruptcy. Despite that, government could rescue the investors and account holders alike from the situation. Since governments are not involved here, a company going bankrupt might mean your money going to zero.

Conclusion:

In my opinion, governments need to start playing the stablecoin game using CBDCs or central bank digital currencies real soon. That would not only pump up the crypto adoption, but also help cover for the issues that have been mentioned above.

What is your stance on Stablecoins?

Let me know in the comments section below. Hit me up on FacebookTwitter or Instagram. If you find this article interesting, please consider sharing it on social media using the links below:

Until Next Time. . .

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rgvdudeja
A techno manager by profession and a hardcore geek at heart. I love to poke my nose into tasks where other usually gave up on. My hobbies include, reading about Blockchain, Cryptocurrency and latest trends in tech industry, playing guitar and yes, memes!
http://pandatechiein.wordpress.com

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