What are stablecoins?

Stablecoins are a form of cryptocurrency that you’re bound to stumble across — or may need to buy at some point — if you plan to start investing and trading digital currencies. However, unlike the majority of cryptocurrencies currently in circulation, stablecoins have a unique attribute, which is that they are “pegged” or tied to other currencies or commodities.

This pairing is designed to make stablecoins, as the name suggests, less volatile than other cryptocurrencies like Bitcoin. This means the market value of stablecoins does not fluctuate as significantly as that of other coins and tokens, and therefore they tend to be a more suitable alternative to other cryptocurrencies in all kinds of situations.

In this AAG Academy guide, we’ll teach you everything you need to know about stablecoins, including what they’re used for, and their pros and cons.

How do stablecoins work?

In many ways, a stablecoin is much like other cryptocurrencies. It is a digital asset that can be purchased and sold through an exchange, traded for other cryptocurrencies, or used to buy goods and services. However, there is one big difference. Unlike most other cryptocurrencies, stablecoins have a market value that’s pegged to something else — something more stable.

That “something else” might be another currency, like the U.S. dollar; a commodity, like oil or gold; or another financial instrument. Because of this, the value of a stablecoin goes up or down in line with whatever it is pegged with, and it tends to fluctuate a lot less than standard cryptocurrencies, which can be incredibly volatile — hence the name stablecoin.

For instance, the Tether (USDT) stablecoin, which launched in 2014 and is now the third-largest cryptocurrency behind Bitcoin and Ethereum in terms of value, is pegged to the U.S. dollar. A single USDT is worth $1, and to ensure that remains the case, Tether claims to be maintaining an asset reserve of $1 for every USDT in circulation.

It should be noted, however, that there are some stablecoins that aren’t pegged to other currencies, commodities, or financial instruments in the same way. Instead, they rely on special algorithms (a piece of code on the blockchain) that link them to another stablecoin of some kind to maintain a stable value.

What are stablecoins used for?

Because they are less volatile than other cryptocurrencies, stablecoins have a wide range of uses that other digital currencies simply wouldn’t be suitable for. 

One of the most common uses of stablecoins is to facilitate trading on exchanges. Instead of buying coins like Bitcoin directly, traders will often buy stablecoins first, then swap them. They may also swap other cryptocurrencies for stablecoins before they sell them. One reason for this is many exchanges do not charge fees when converting stablecoins into fiat currencies.

Stablecoins are also handy for investing in smaller cryptocurrency projects whose tokens are not available on centralized exchanges, which means they cannot be purchased with conventional fiat cash. Other stablecoin uses include liquidity pools, and sending money between different countries without fees and lengthy processing times.

What are the most popular stablecoins?

Tether (USDT), which we mentioned above, is one of the most popular stablecoins in use today, but it’s certainly not the only one. Here are the biggest stablecoins after Tether:

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

What are the benefits of stablecoins?

As we’ve already touched upon, the biggest benefit of stablecoins is a more stable market value. Even Bitcoin, the biggest cryptocurrency on the planet, has been known to see significant fluctuations in value over a relatively short period of time. For example, the current price of a single BTC, as of September 14, 2022, is just over $20,000. However, back in April — less than six months ago — a single BTC was worth over $45,000.

These rather wild variations in value, while they can be great for traders who work to make the most of them to turn a profit, mean that most cryptocurrencies are largely unsuitable for certain things, such as paying for goods or sending money between different countries. If someone in another country sent you $1,000 worth of Bitcoin for some work you did for them, and by the time you cashed it in, it was only worth $600, you wouldn’t be too happy.

This is one of the biggest reasons why merchants are hesitant to accept cryptocurrencies in exchange for goods and services, even though in some cases, it may be more convenient — especially for cross-border payments. It’s difficult to price products in cryptocurrency since their value fluctuates so much, and merchants could end up selling goods at significantly less than their normal price if the value of a particular cryptocurrency crashes before they have had a time to update pricing or swap the cryptocurrency into conventional cash.

In all these scenarios, however, stablecoins provide a viable alternative to other cryptocurrencies because they come with the same benefits, but their market value — in most cases, at least — is nowhere near as volatile. That’s why many traders tend to buy stablecoins initially before swapping them for another cryptocurrency.

What are the problems with stablecoins?

Before you start buying up different stablecoins, however, it’s important to be aware that they’re not completely perfect. Stablecoins may be more stable than other cryptocurrencies, but they have some risks of their own. For instance, those that are algorithmically tied to other cryptocurrencies can still crash if something happens to the cryptocurrency they’re pegged to.

Those that are backed by conventional fiat cash reserves are less susceptible to this, but like other stablecoins, there is pressure on them to be regulated. The rapid growth of stablecoins has led to scrutiny from many countries, which are concerned about their potential effect on the rest of the financial system. Should regulation come into play at some point, stablecoins could be forced to undergo regular audits, and they may have to abide by bank-like rules.

That could mean that, in the future, stablecoins cannot be used as freely as other cryptocurrencies, and that users have to give up certain personal information before they can trade them — in the same way you have to open up a bank account before you can send and receive cash. This would eliminate one of the biggest things that make digital assets so appealing, which is the ability for anyone to trade mostly anonymously.

References

• https://www.investopedia.com/terms/s/stablecoin.asp
• https://www.ecb.europa.eu/pub/financial-stability/fsr/focus/2021/html/ecb.fsrbox202111_04~45293c08fc.en.html
• https://www.cnet.com/personal-finance/crypto/what-are-stablecoins-and-are-they-less-risky-the-details-crypto-investors-should-know/
• https://www.coindesk.com/learn/whats-the-point-of-stablecoins-understanding-why-they-exist/
• https://coinmarketcap.com/view/stablecoin/