All you need to know about stablecoins

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Stablecoins occupy a special place in the crypto world. They act as a bridge between the real economy and the crypto world, and accordingly combine the features of real and virtual assets.

Features of stablecoins

Classic cryptocurrencies are not backed by anything and are not controlled by any centers. The issue of coins is carried out according to a given algorithm, and while the project is developing, it is impossible to influence it artificially. Moreover, developers seek to protect networks from the spontaneous (and even more so intentional) formation of centers that can affect the functioning of the network.

The price of cryptocurrencies is set by the market. This is one of the reasons for the unpredictability and extremely high volatility of digital assets. There was a need for a tool to stabilize the price of virtual assets and stablecoins appeared on the market. Two ways to create stable crypto assets have been implemented, and both continue to develop.

Fiat-backed stablecoins

Collateralized stablecoins were the first and became widespread. In 2014, USDT (Tether) was launched, which still remains the leader among stablecoins and is in the TOP-10 largest cryptocurrencies. Later entered the market

  • BUSD
  • GUSD
  • USDC.

These well-known and popular fiat-backed stablecoins are issued by major cryptocurrency exchanges and are pegged to the US dollar. Coins of a new type have occupied a free niche of low-volatility cryptocurrency instruments. They greatly simplify the work of exchanges, are used for risk management, and also as a universal settlement tool. Popular stablecoins are available on all cryptocurrency exchanges and usually form the maximum number of trading pairs. For example, the ZEC to USDT exchange is available on all platforms where zec is traded.

According to the statements of the issuing companies, classic stablecoins are backed by real money, which is stored in special company accounts or government bond packages in a ratio of 1:1. That is, the price of one coin is ideally equal to $1, although in practice there are slight deviations in one direction or another.

It is not always possible to check the reality of securing stablecoins. That is, their functioning is to a certain extent based on the issuer’s word of honor.

Since the convenience of using classic stablecoins exceeds doubts and risks, ordinary users have little interest in their real security. The stability of the price of the coin is largely based on the trust in the security asset with minimal use of market mechanisms and technical methods.

Collateralized stablecoins have a centralized issuer. This is the company that is legally and economically responsible for securing digital coins. Strictly speaking, classic stablecoins are not a cryptocurrency per se, but a tokenized fiat. They function like the already familiar electronic payment systems, but are based on the blockchain.

Algorithmic stablecoins

Unlike secured stablecoins, their algorithmic counterparts are completely decentralized and function like typical cryptocurrencies. The first algorithmic coin was launched in 2013 on the Bitshares blockchain.

The most famous decentralized stablecoin in existence today is DAI. It launched in 2017 on top of the Ethereum blockchain. The binding of the value of the coin to the dollar is supported by technical and market mechanisms based on smart contracts, which contain a price stabilization algorithm.

Algorithmic stablecoins operate on top of a public blockchain, backed by its underlying cryptocurrency. To launch a stablecoin, native blockchain tokens are locked in a smart contract. To ensure the stability of the price of the coin, the Collateral Debt Position mechanism is used, supplemented by redundant collateral (about 50% on average).

When creating an algorithmic stablecoin, fiat currencies are not used and such assets are not connected to the traditional financial system. They do not have centralized issuers and are not subject to regulators.

Banking and government stablecoins

In the rapid development of cryptography, central banks saw a threat to the traditional financial system. A few years later, banks themselves became interested in digital currencies and began issuing their own stablecoins, the so-called central bank digital currencies (CBDC). In fact, we are talking about the movement of non-cash turnover, and in the more distant futureasset – and the entire banking system in the blockchain.

Thus, banks are striving to create a controlled, stable and secure financial system in which there will be orders of magnitude less incentives to create cryptocurrencies. CBDCs, on the other hand, will operate under the control of central banks, similar to sovereign fiat currencies, and will become legal tender.

The first state digital currency was launched by Venezuela, a little later by the Bahamas. A digital yuan is being tested in China, preparations are underway for the launch of digital dollars and euros.

Prospects for the development of stablecoins

The existence of three types of stable digital coins suggests the upcoming fierce competition between them.

From the point of view of an ordinary user, fiat-backed coins and CBDC are practically the same thing. As the introduction of CBDC is likely to become another banking product. In this case, tokenized money will receive a huge user base and a high degree of trust, backed by the reputation of traditional financial institutions.

Algorithmic tokens seem to be the most vulnerable, although it is still premature to draw far-reaching conclusions.