Most cryptocurrencies were created to become a means of payment. The problem is that because of their small capitalisation, even the most popular cryptocurrencies often experience a great deal of price fluctuations. That is why, for example, a cup of coffee can cost 10 conventional coins, tomorrow it may cost 20, and the day after tomorrow, only 5. Stablecoins were created to solve such problems.
Stablecoins are cryptocurrencies that maintain a stable cost based on external assets, in the form of fiat currencies (dollar and euro), exchange commodities (gold or oil), another cryptocurrency (Bitcoin or Ethereum), or a set of smart contract protocols.
They aim to solve the problem of high volatility, faced by the majority of traditional cryptocurrencies, while preserving all their advantages, including decentralisation, security, low commissions, confidentiality, and transparency.
The most famous example is the platform, Tether, which issued the coins based on the US Dollar (USDT), Euro (EURT), and Chinese Yuan (CNYT). In the summer of 2020, USDT capitalisation exceeded USD $13.5 billion, which allowed it to become the world’s third largest coin by capitalisation.
Stablecoin market overview. Source: blockchain.com
There are many stablecoins in the cryptocurrency market. Based on the type of security, they are usually divided into four types. Each has its own working principle, advantages and disadvantages. We will tell you more about each of them.
This type includes all cryptocurrencies, the rate of which is backed by fiat money: Dollar, Ruble, Yen, etc. The idea is to support the cost of cryptocurrency with real money in bank accounts in a 1:1 ratio, due to which the holder of stablecoins can change them for real money at any moment and the rate remains unaffected.
The illustration below shows how it works:
As you can see, the scheme is quite simple: the issuer first makes a deposit to a bank account and then issues tokens for the amount deposited. Whenever the tokens’ owner exchanges them for fiat, the equivalent amount of tokens is taken out of circulation or destroyed. If the issuer needs to increase the money supply of stablecoins, they simply replenish the balance of the deposit for the necessary amount.
A good example of the fiat-backed token is USDT — the most popular cryptocurrency equivalent to a US Dollar with a rate of 1 USDT = 1 USD. Another example is TUSD, launched by specialists from Google, Palantir, Berkeley, and even Stanford University.
We should also recall the project “Libra” by Facebook, which changed the vector of development from the global cryptocurrency to the platform for launching fiat-backed stablecoins because of disagreement with the American regulator.
These are cryptocurrencies whose rate is tied to the value of commodities. The most common being gold and precious stones, since these are considered a safe haven. If the collateral is gold, then one coin is the equivalent of a certain weight of gold (for example, 1 token is equal to 1g of gold or 1 carat for diamonds).
The figure below shows how it this works on an exchange called “Digix”:
As with fiat, the issuer can only issue tokens after buying the investment – gold coins and/or bars from the dealer’s banks. The amount of security must also be equivalent to the money supply of tokens.
A good example of a commodity-collateralised stablecoin is the DGX token, backed by real gold stored in a “Safe House” vault located in Singapore. To ensure transparency and increase confidence in DGX, this repository is reviewed every three months.
These are cryptocurrencies backed by other virtual assets, usually with the largest market capitalisation (Bitcoin or Ethereum). As a rule, several coins act as collateral in order to distribute risks better. Such stablecoins are mainly used on decentralised P2P lending platforms.
This is how it works:
Almost all stablecoins work based on smart contracts that block a certain amount of currency (security) in the smart contract, and then create a fixed amount of new coins.
The platform “Wrapped Bitcoin” (WBTC) uses the support of cryptocurrency, the rate of which is backed by bitcoins in the ratio 1:1.
Such coins use an algorithmic approach to increase/decrease the cryptocurrency money supply in the same way as the Central Bank prints or destroys money to address the problem of inflation. The main purpose of these coins is to maintain the rate at the same level (for example, $1).
EXMO follows the trends of stable coins and can offer two stable cost assets: USDT and USDC. By the way, we offer a special deal for our users who trade USDT — 0% commission for all pairs with USDT. The only exception is the USDC/USDT pair. You can exchange USDT and USDC tokens with more than a dozen currencies on the platform!
According to Marco Di Maggio, Associate Professor of Harvard Business School, stablecoins are the next stage of development of e-commerce. They are more convenient and less expensive than other cryptocurrencies and fiat money. Everybody will create them: startups, large marketplaces, as well as states. And it will happen soon enough.