What are Stablecoins and how do you Use them?
What is Stablecoin?
A stablecoin is a type of cryptocurrency that is designed to have a stable value, typically pegged to a reserve asset or a basket of assets. Unlike other cryptocurrencies such as Bitcoin or Ethereum, which can be highly volatile in terms of price, stablecoins aim to provide stability and minimize price fluctuations.
Stablecoins offer several benefits, including providing stability for users to store value, facilitating easier and faster transactions, and enabling easier access to cryptocurrencies for individuals and businesses. They are commonly used in crypto trading, remittances, decentralized finance (DeFi) applications, and as a hedge against volatility in the crypto market.
Stablecoins achieve their stability through different mechanisms depending on their type.
Types of Stablecoins and examples
Centralized stablecoins:
Centralized stablecoins are cryptocurrencies that are designed to maintain a stable value relative to a specific asset or currency. These stablecoins are typically issued and controlled by a centralized entity, such as a company or a financial institution. The centralized entity holds reserves of the underlying asset or currency that back the stablecoin's value.
Here are a few examples of centralized stablecoins.
Tether (USDT):
Tether is one of the most well-known centralized stablecoins. It is pegged to the value of the U.S. dollar, with each USDT token representing one U.S. dollar held in reserve.
USD Coin (USDC):
USD Coin is a stablecoin launched by Circle and Coinbase. It is also pegged to the U.S. dollar, with each USDC token backed by one U.S. dollar held in reserve.
Binance USD (BUSD):
Binance USD is a stablecoin launched by Binance, one of the largest cryptocurrency exchanges. It is also pegged to the U.S. dollar, with each BUSD token backed by one U.S. dollar held in reserve.
Paxos Standard (PAX):
Paxos Standard is a stablecoin issued by Paxos. Similar to other centralized stablecoins, it is backed by U.S. dollars held in reserve, with each PAX token representing one U.S. dollar.
Gemini Dollar (GUSD):
Gemini Dollar is a stablecoin issued by Gemini, a cryptocurrency exchange founded by the Winklevoss twins. It is pegged to the U.S. dollar, with each GUSD token backed by one U.S. dollar held in reserve.
These centralized stablecoins provide a means of transferring value quickly and efficiently within the cryptocurrency ecosystem while reducing the price volatility associated with many other cryptocurrencies.
Gold backed stablecoins:
A gold-backed stablecoin is a type of cryptocurrency that is backed by physical gold reserves. It is designed to provide stability and security by linking the value of the stablecoin to the price of gold. The idea behind a gold-backed stablecoin is to combine the benefits of cryptocurrencies, such as fast and secure transactions, with the stability of a tangible asset like gold.
Here are a few examples of gold-backed stablecoins.
Tether Gold (XAUT):
Tether Gold is an ERC-20 token issued on the Ethereum blockchain by Tether, the company behind the popular USDT stablecoin. Each XAUT token represents one troy ounce of gold held in a Swiss vault. Tether claims that the gold reserves are regularly audited to ensure transparency and accuracy.
Paxos Gold (PAXG):
Paxos Gold is an ERC-20 token issued by Paxos, a regulated financial institution. Each PAXG token represents one fine troy ounce of a 400 oz London Good Delivery gold bar stored in Brink's vaults. Paxos allows token holders to redeem their PAXG tokens for physical gold if they meet certain requirements.
Digix Gold Token (DGX):
Digix Gold Token is an ERC-20 token built on the Ethereum blockchain. Each DGX token represents one gram of gold. Digix claims to have partnered with reputable auditors to conduct regular audits and ensure that the gold reserves backing the tokens are properly accounted for.
Algorithmic stablecoins:
Algorithmic stablecoins are a type of cryptocurrency designed to maintain a stable value through the use of algorithms and economic mechanisms. These stablecoins aim to provide price stability, similar to traditional fiat currencies, while leveraging the benefits of blockchain technology. Here are a few examples of algorithmic stablecoin
DAI (MakerDAO):
DAI is one of the most well-known algorithmic stablecoins. It operates on the Ethereum blockchain and is governed by the MakerDAO decentralized autonomous organization. DAI maintains its stability by using collateralized debt positions (CDPs), where users lock up cryptocurrencies like Ether (ETH) to generate DAI tokens.
Frax (FRAX):
Frax is an algorithmic stablecoin that operates on the Ethereum blockchain. It combines elements of both collateralized and algorithmic stablecoins. Frax maintains stability by allowing users to redeem FRAX for a collateralized stablecoin, FRAX Shares (FXS), or for a combination of collateral and algorithmic stabilization.
Empty Set Dollar (ESD):
Empty Set Dollar is an algorithmic stablecoin built on the Ethereum blockchain. It doesn't rely on collateralization but instead utilizes a dynamic supply adjustment mechanism. ESD's supply expands and contracts based on market conditions, aiming to maintain a target price of $1.
Ampleforth (AMPL):
Ampleforth is an algorithmic stablecoin that adjusts its supply daily based on market conditions. Instead of targeting a fixed price, AMPL aims to maintain a stable purchasing power over time. When the price of AMPL deviates from a target value, the supply is adjusted accordingly, increasing or decreasing the number of tokens held by each user.
How are stablecoin used?
They are primarily used to address the price volatility commonly associated with other cryptocurrencies like Bitcoin or Ethereum. Here are some common use cases for stablecoins.
Medium of Exchange:
Stablecoins can be used as a digital currency for everyday transactions. Users can send and receive stablecoins quickly and at lower fees compared to traditional banking systems. Some stablecoins are specifically designed for cross-border payments, offering fast and cost-effective remittance services.
Store of Value:
Stablecoins provide a reliable store of value due to their stable price. Cryptocurrencies like Bitcoin can experience significant price fluctuations, making them less suitable for storing wealth. Stablecoins allow individuals and businesses to preserve their funds in a digital form without worrying about value depreciation.
Trading and Investing:
Stablecoins are commonly used on cryptocurrency exchanges as a trading pair with other cryptocurrencies. Traders often use stablecoins as a way to mitigate risk during periods of market volatility. By converting their crypto holdings into stablecoins, traders can avoid potential losses caused by sudden price swings.
Decentralized Finance (DeFi):
Stablecoins play a crucial role in decentralized finance applications. They enable users to access various DeFi protocols such as lending, borrowing, yield farming, and decentralized exchanges. Stablecoins provide stability within DeFi ecosystems while still leveraging the benefits of blockchain technology.
Hedging and Risk Management:
Stablecoins offer a tool for hedging against the volatility of other cryptocurrencies. Investors and traders can move their funds into stablecoins to reduce their exposure to market fluctuations temporarily. This strategy helps to manage risks and protect against potential losses.
Remittances:
Stablecoins have gained popularity for cross-border remittances. Workers who send money to their families in different countries can use stablecoins to facilitate fast, low-cost transactions. Stablecoins eliminate the need for intermediaries, reducing fees and improving accessibility to financial services.
