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Saturday, August 19, 2023

Stablecoins, their Types, and how they Differ From Traditional Crypto

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The cryptocurrency market is historically very young and is in the stage of active formation. Digital coins are high-risk assets, but this property paradoxically contributes to the growth of popularity among investors and traders.

Cryptocurrencies were created as a more convenient, reliable and completely self-regulating alternative to the traditional financial system. Now digital assets can be sold, bought, accumulated, loaned, exchanged SC to ETH or in almost any other direction. However, the extremely high exchange rate volatility of popular digital coins makes it very difficult to use them for everyday payments.

The solution to the problem was stablecoins, which became one of the risk management tools. Stablecoins are digital assets that are tightly linked to other assets. Most often, sovereign fiat currencies serve as a value-collateral asset, less often bank metals, other traditional assets, or popular cryptocurrencies. So, stablecoins:

  • Have a fixed or stable exchange rate.
  • Convenient for settlements, capital storage, investment portfolio protection during periods of extreme market volatility.
  • Simplify cryptocurrency trading.
  • Improve the quality and speed of cryptocurrency exchanges.
  • Used for fast and inexpensive international transfers.
  • Used to protect funds from inflation of local fiat currencies.

The mere fact of the existence of stablecoins increases the credibility of cryptocurrencies in general and contributes to their acceptance. The higher the trust in digital money, the easier it is to use it in the real world and integrate it into the real economy.

Types of Stablecoins

Stablecoins are classified by asset type and value collateral mechanism.

Tether (USDT) was the first ever stablecoin. This is the most famous and largest stablecoin, which quite steadily holds high positions in the TOP-10 cryptocurrencies. USDT is not the only Tether digital coin, there are tokenized versions of the British pound and euro on the market. In addition to USDT, there are other digital coins backed by the dollar or pegged to it:

  • USD Coin (USDC)
  • TrueUSD (TUSD)
  • Pax Dollar (USDP)
  • Binance USD (BUSD)
  • Dai (DAI)
  • FeiUSD (FEI)
  • USDD (USDD)

All these coins are centralized, that is, controlled by the issuing company.

Some stablecoins are backed by a commodity. For example, the Digix Gold coin (DGX) is tokenized gold and each coin is backed by one gram of the physical precious metal. SwissRealCoin is backed by a portfolio of Swiss real estate. These coins are little known to a wide range of users and are also controlled by issuers.

Stablecoins backed by other cryptocurrencies. The DAI coin, in particular, belongs to this group. Its value is pegged to the dollar, but backed by Ethereum. Such coins are more decentralized, but they are often managed by decentralized projects.

Algorithmic stablecoins are completely decentralized and have no physical backing. Pricing is supported by a smart contract, and the dollar peg is regulated by special algorithms or economic incentives.

Centralized vs Algorithmic

Centralized stablecoins are backed by low volatility traditional assets with a good reputation. That is, the digital currency receives approximately the same properties as the collateral asset. It is stable, predictable and liquid. Popular coins are convenient for mutual settlements and capital storage. They are much easier to use as the base currency for trading on cryptocurrency exchanges. Converting USDT to ETH is faster and easier than USD.

However, centralization also has a dark side. First of all, it contradicts the basic principles of the crypto world. Any difficulties with the issuing company can provoke problems for all coin holders. This may be the manipulation of reporting, claims from regulators or the misuse of reserves.

Not everything is smooth with algorithmic stablecoins. In the first ten days of May, the algorithmic coin TerraUSD (UST) collapsed to $0.76. To maintain the value of the coin, the Luna token was used. The algorithm failed, and the subsequent collapse of the Luna was a real disaster.

Challenges and Risks

In fact, stablecoins act as a link between the crypto world and the traditional financial system, and the number of such bridges is increasing. However, the stability of new coins depends not only on the collateral asset, but also on the viability of the project. Therefore, new stablecoins should be treated very carefully.

In addition to the risks typical of cryptocurrencies, tokenized assets receive the same risks as a collateral asset. Linking to real assets not only increases the credibility of the coin, but also tightens the legal requirements for its operation.

Prospects for the use of Stablecoins

The future of this type of coin is not yet clear. They really simplify the process of integrating cryptocurrencies into the global economy. However, it is possible that over time digital money will come to their place, which will be controlled by the state.

Also Read: Crypto News Alerts

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