Stable Coins – Full Guide
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The crypto industry has really grown in the past three years. More and more cryptocurrencies are being developed as more people get to know and understand how this industry operates. While many cryptocurrencies come with their unique functionalities and get their value from the factors of demand and supply, a new breed of cryptos called stable tokens is cropping up.
These tokens are called stable because their value is pegged on actual assets like gold and fiat currencies. one token of the stable crypto is equivalent to one US dollar and vice versa. These coins are going to bring a new dimension to the crypto industry.
We’ll go through the details of what these stable coins or tokens are, and the benefits they are to bring to the digital coins industry. We’re also going to learn about how they work and the various types available in the market at the moment.
What are stable coins?
A stable coin or otherwise a stable crypto is a digital token whose value is pegged to the value of traditional money or fiat currency. Like fiat currencies, a stable crypto is designed to maintain a stable value over a given period of time. These tokens are less volatile. They aim to work both as traditional money with all the qualities of fiat currency and still maintain the principles of cryptocurrencies such as security and decentralization.
How Stable Coins Work
Stable coins work more or less like fiat currencies. They can be a medium of exchange, store of value and a unit of account, but they have some setbacks. Unlike other digital coins, stable coins are pegged to some stable asset such as gold or a strong currency such as the USD.
Being pegged to such assets validates their identity as stable coins. The main idea is to cushion against the volatile nature of cryptocurrencies. These coins achieve this by pegging either to the USD or other major currencies, Gold, the consumer price index or some other major cryptocurrencies.
Their value is always placed at the ratio of 1:1, for example, one issued token of Tether USD, will have an equal value as one USD. You can then use one token of Tether to purchase anything that is valued at one USD. If you so wish to convert your tokens to fiat currency, you will get the corresponding value of the number of tokens you hold. But, there are some deviations to this simple explanation as we shall see later in this article.
The Types of Stable Coins
There three main types of stable coins. These are:
- Fiat collateralized
- Crypto collateralized
Fiat collateralized tokens have an equal corresponding value of fiat currencies. In this type of token, an equal amount of the fiat currency must be held by a custodian such as a bank to back up the token. A holder of this token can redeem their token and convert it to cash at any time.
The value of the token and the fiat currency is always at the ratio of 1:1. A good example of a fiat collateralized token is the Tether token (USDT). Tether should always trade at the value of the currency it is pegged to (1USDT = 1USD). It is good to note though, that Tether has been under a lot of scrutinies. There have been claims that the millions of Tether issued tokens do not have sufficient reserves.
Another example of a fiat collateralized token is True USD. This token is built upon on the TrustToken platform and its reserves are held in escrow accounts. The escrow accounts are often audited and also provide legal protection to token holders giving this token its authenticity. Its platform has collaborated with law firms such as Cooley and WilmerHale established a legal framework for the token.
Some other collateralized tokens are backed by other measures of value like gold and oil. For instance, Petro, the Venezuelan government token is backed by a barrel of crude oil. However, the same government declared the token illegal. Digix (DGX) is another collateralized token backed by gold. One DGX token is backed by 1 gram of 99.99% gold. The token is not as stable though considering how the value of gold fluctuates with respect to fiat currencies.
These cryptocurrencies are backed using the reserves of other cryptocurrencies in an effort to avoid using central custodians like banks. This system also helps to achieve the price stability of the tokens in a decentralized system.
In this system, the stable token is over-collateralized to absorb any price fluctuation of the backup cryptocurrency. For instance, $1 of a stable coin is backed up by $2 of the collateral coin. This back up amounts to 200% creating an allowance should the backup coin lose value significantly.
An example of a coin that is backed up by another one is Dai. This token is pegged to the USD and is backed up by Ethereum. If you want to hold this token, you simply hold it up against two times as much ether as the Dai token. Due to the nature of smart contracts that are autonomous and with trustless environments, a user only needs to pay back the Dai debt to access their collateral. The reserves can be sold automatically increase the collateral loses its value to a certain point.
Another example of a crypto collateralized token is BitUSD that is collateralized by BitShares. BitShares crypto uses its native network currency as the collateral. They create market pegged assets or tokens such as BitCNY, BitUSD, and BitGold which holders can trade them as futures.
Crypto collateralized coins might be more decentralized and can be easily liquidated than their fiat counterparts but are not likely to achieve the stability to enable them to work as traditional fiat currencies.
These coins simulate the stability system used by fiat currencies in traditional reserve banks and still maintain their decentralization and independence. These coins do not have any assets or coins backing them up. They use the seigniorage shares approach.
The seigniorage approach uses smart contracts in the same manner reserve banks handle fiat currencies. By reprogramming smart contracts to work as reserve banks, they are able to increase and decrease the supply of coins to maintain the value of that coin as close as possible as the value of its pegged asset.
Non-collateralized tokens work on the traditional economic principle of supply and demand. The smart contracts decrease and increase the supply of the tokens depending on the value of the coin at a particular time. The smart contracts buy coins to decrease the supply and increase their value if they are trading below the market pegged asset. They do this with the excess profit in the system. When there is no excess profit to buy coins, shares are issued giving holders of the tokens rights to future excess profits.
Examples of coins using this system are Saga and Basis, formerly known as Basecoin. Saga is backed by a variable fractional reserve that is pegged to the Special Drawing Rights (SDR) of the International Monetary Fund. Basis aims to peg to the US dollar in the short term and then shift to Consumer Price Index (CPI).
Are Stablecoins the Future of Crypto?
While they seem to have a promising future, it is very difficult to determine the fate of stable coins in the long run. First and foremost, for stablecoins to achieve mass adoption, they must find a solution to the instability challenge. Finding this solution will be very challenging considering the volatile nature of most cryptocurrencies. Stable coins like other cryptos are susceptible to price fluctuations.
Another challenge these coins face is the issue of decentralization. If stable coins are to become the future of crypto, then they must maintain the decentralization ideology of cryptocurrency. We’ve already seen fiat backed coins deviating from this norm, meaning that they cannot be the future of crypto. And even if they were to be, then they would need a third-party custodian that cannot be manipulated which will be very difficult.
Cryptos also face the challenge that they can be destroyed instantaneously. The value of crypto is determined by the users of that particular crypto belief that the token will remain valuable. If the users lose faith in any particular coin and start liquidizing it, then it loses value and may eventually collapse. This challenge also faces stable coins, but they seem to be finding new mechanism to give them value beyond the belief of the coins’ holders.
Despite these glaring challenges, a lot of crypto enthusiasts believe that stable coins are not only the future of crypto but the future of the entire monetary system. The US dollar, the strongest currency in the world is not backed by any tangible assets, yet most people in the world believe in it. Stable coins are set to change this belief system by introducing to the world financial system a currency that has some asset back up but is not controlled by any central institution or government. This system will give everyone the financial freedom that third parties have for a long time put restrictions on.
Apart from the stable coins that are backed by the USD which is unstable in itself, there is a new coin in the block called Pecunio Gold Coin (PCG). This coin will be backed by actual gold reserves like it was before the currency financial system came into play. One PCG will be backed by exactly 1 gram of 999.99 gold approved by the London Bullion Market(LBMA).
PCG will also provide a measure of stability and security to cushion users from sudden fluctuations. With gold tokens being part of the blockchain, there will be a measure of security as the gold assets will cushion against price volatility. Pecunio seeks to enable the mass use of cryptos and allow stable crypto coins to be used as a store of value.
If this platform manages to set up this system as described, then stable coins might just be the future of cryptos and the replace the traditional monetary system. But this is easier said and done. Only when the system begins to operate will we see whether it will be viable or not.
Top Stable Coins Today
As noted throughout this article, there are three main categories of stable coins out there. Under each category are a number of stable coins. The top ones as of the moment are Tether, TrueUSD, and BitCNY. We’ll have a closer look at each one of them.
Tether is a stable crypto coin backed by the USD, Euro, Yen and other major fiat currencies. Every token is backed by fiat currency of a similar value stored in a custodian bank. It is thus a fiat currency backed stable coin.
Tether platform is built upon open and transparent blockchain technologies. The coin’s reserve holdings are always published for verifications and auditing by professional auditing firms giving this coin its authentication. Their reserves are always equivalent to the number of issued tokens.
This is an ERC20 stable coin developed by Trust Token. TrueUSD (TUSD) is a stable coin pegged on the USD. Like its counterpart Tether, one coin of TrueUSD is equal to one dollar. The value should always stand at the ratio of 1:1. This means that you can redeem the number of coins you have to an equivalent amount in USD.
TrueUSD has a legal framework collaboration with WilmerHale and White & Case. Its network of compliance, fiduciary and bank partners provide a cushion to some extent of stabilizing this coin. These partners ensure consistent verification. It also uses escrow accounts to ensure full protection of back up funds. TrueUSD team does not access the funds you deposit in trust institutions and is never involved in the transfer of funds.
However, a few days ago, TrueUSD showed characteristics of traditional digital coins after the exchange Binance announced that it was going to trade it. Ideally, this stable coin is supposed to stay as close as possible to the value of the dollar. Instead of the coin doing this, its value increased by almost 40% in a matter of hours. This volatility shows that this stable coin is still not fit to be used for day to day transactions by the masses.
This stable coin is based on BitShares blockchain and pegged on to the Chinese Yuan. Bitshares is an exchange that trades using smart coils. Like those pegged on the USD, the value of this coin to the Yuan is 1:1. This means that if you hold x amount of BTS coins, they will at any one time be equivalent to x amount of Chinese Yuan. BTS is used as collateral in this system. The value of BitCNY depends on the value or the strength of the Chinese Yuan.
In a Nutshell
Cryptocurrencies are developed to bring about fairness and a true value of money in the financial industry. They are meant to protect users from unscrupulous regulations of financial institutions that make financial transactions expensive and cumbersome. Crypto coins cannot act as units of exchange or store of value due to their volatile nature. This is where stable crypto coins come in. The main aim of the stable tokens is to provide all the functions of fiat currencies, but still, maintain fairness and control in the hands of the people who use them and not financial third-party institutions.
Stable coins provide stability inherent in fiat currencies. They have the ability to gain mass adoption as well as widespread circulation and be used for day to day transactions if only developers can come up with solutions to the challenges inherent with these cryptos.
Thank you for being part of our family as we continue learning about the crypto industry. We hope that you have learned something valuable about stable coins. For more informative articles such as this, keep checking our site.