If you go and ask anyone about cryptocurrency, they are going to be quick to mention bitcoin, ethereum, and the high volatility that goes along with these coins.
For the longest time, the crypto market has been viewed as a more dangerous version of the stock market, with prices fluctuating at much higher rates each day.
While that might be true with many cryptocurrencies, there are some coins out there that help bring stability to the crypto market for those who are looking for it.
These coins have been given the creative name of stablecoins. Today we are going to be talking about what stablecoins are and we are going to go over a few examples that you can purchase on any crypto exchange.
Investing in stablecoins can help add more diversity to your crypto portfolio in a safe manner. Before you invest in stablecoins however, we want to ensure you have an understanding of what they are and how they work.
What Are Stablecoins?
Cryptocurrencies are normally volatile because they are not tied to a stable asset. This is why you will see bitcoin and Ethereum making rapid jumps every day in the market.
Stablecoins however are generally tied to a more stable asset and in most cases, it is fiat cash.
When we discuss some of the stablecoins that are out on the market, you are going to see that several of them are tied to fiat cash issued by governments.
The way a stablecoin works is that the entity behind the coin will create their own reserve or storage in which they store the asset that is being tied to the stablecoin.
For example, let’s say that there is a stablecoin that is tied to the US dollar. The creator of this coin would then acquire and store US dollars in a reserve to back this stablecoin.
In most cases with a stablecoin, you are going to see a 1:1 connection between the coin itself and the asset that it is tied to. Continuing on the previous example, if there are one million stablecoins backed by the US dollar, the entity is going to be storing 1 million USD in the bank.
This works as a sort of protection and collateral for the stablecoin and this creates a much safer environment in the crypto world.
As you can see, the goal of a stablecoin is to have stability in a market that is full of uncertainty. Stablecoins don’t always have to be tied to a stable asset however in order to reach a stable price.
In one circumstance, you can use your own cryptocurrency as collateral to acquire stablecoins. You will see this on websites such as Maker which offers DAI as a stablecoin in exchange for your crypto as collateral.
The final type of stablecoin is quite interesting and it is called an algorithmic stablecoin. There is no collateral behind these coins at all, and instead, the quantity of coins in the market is modified to reach its price target.
Let’s say for example a stablecoin has a price target of $1. If this coin drops below $1 to $0.80, the system will destroy coins to reduce the quantity, therefore increasing the price. The opposite happens if the price rises above $1. The system will create new coins to increase supply, thus reducing the price back down to $1.
What Can a Stablecoin Be Tied To?
In general, you are going to see stablecoins tied to 3 different assets.
- Precious metals such as gold and silver
- Other cryptocurrencies
Make sure you are reading up about what your stablecoin uses as collateral before you purchase it, as that can play a role in volatility and how useful your coin is going to be.
The Most Popular Stablecoins
Now that we have an idea of what stablecoins are, it’s now time to talk about some of the most used and popular stablecoins that you are going to see on the market.
Stablecoins might not be a sexy option when compared to altcoins and things such as bitcoin, however, they do have their uses and we will discuss that later on in the article.
It's worth mentioning as well that stablecoins are a healthy way to portion out your portfolio due to their low-volatility risk.
Tether or USDT is the most popular stablecoin out there and inherited its name because it is tethered to the US dollar. It launched back in 2014 and has been one of the most used coins and is available on almost all crypto exchanges.
Tether is most useful for people who are trying to send large amounts of money. Sending several million US dollars across a border would subject it normally to strict capital controls, especially if you are from China. If you send the money in USDT however, it will easily be received by the other party.
Because Tether is tied to the US dollar, it makes the conversions incredibly simple. It is one of the safest stablecoins to use for transactions as there is never going to be any question of how much the stablecoin is going to be worth.
True USD is very similar to Tether in the fact that it is also tied to the US dollar. It was created back in 2018 and has become the second-largest stablecoin on the market. True USD can be used in the same way Tether can so there is not much more to add here other than it can be used to diversify your portfolio.
Paxos Standard is another stablecoin that has been created to be tied with the US dollar. It was created because of a controversy regarding Tether. Claims were being made about USDT and people were questioning the collateral behind it.
As a result, Paxos Standard was created, and just like the other stablecoins on this list, it shares a 1:1 connection with the US dollar.
Another stablecoin, another coin that is tied directly to the US market. USD coin is a stablecoin that is backed by Coinbase. If you aren’t familiar with Coinbase, they are currently the largest crypto exchange out there.
Coinbase has just recently allowed USDT to be traded on their website, if you wanted a stablecoin before that, you would have to have used a USD coin.
The final coin we are going to mention today is another coin that is not only backed by the US dollar but is also backed by a crypto exchange.
Binance is another major player in the crypto market and they have created their own stablecoin that can be used for trading and transactions on their website.
Why Use Stablecoins?
At first glance, you might ask, why would I ever want stablecoins? That’s a fair question to ask, as, at the end of the day, it’s equivalent to holding USD.
There are a few unique advantages however that stablecoins offer in the crypto world. This will help to give you an understanding of why you might benefit from having stablecoins in your portfolio.
The first reason is that stablecoins are borderless. They are exactly like the USD but have the ability to move across borders easily like any cryptocurrency would.
This makes sending across countries that much easier, especially in larger quantities. The next reason is that they transfer quickly. One of the major issues with some cryptocurrencies is that they can have long transfer times. Stablecoins are able to transfer quickly and easily to the other party.
This is because they don’t need a 3rd party to verify the transfer. The best part about this? No 3rd party fees are required as well when working with stablecoins.
Stablecoins also can help with day trading in the crypto market. You can easily transfer altcoins to stablecoins if you notice the prices dropping or fluctuating. Once this is done, you can easily trade right back in.
The final reason is that there is transparency to using stablecoins. Any transactions are recorded into a public ledger that can be monitored and seen by anyone. This makes it more transparent than fiat currencies.
So there definitely are a few advantages towards using stablecoins and it is definitely worth considering investing in. There are a few disadvantages or things to be cautious about however as well with stablecoins.
Disadvantages of Stablecoin
Stablecoins are completely centralized. Cryptocurrencies are often known for being decentralized with one governing body not having complete control over it. This is not the case with stablecoin as there is going to be an entity that owns the currency as they were the ones who created it.
The biggest disadvantage towards stablecoins however is the lack of growth with them. As most stablecoins are connected to the US dollar, it only moves when the US dollar does and even then, your stablecoin is as valuable as a one-dollar bill in your wallet. If you want your money to grow over time, you are going to want to invest it in some other cryptocurrency.
Overall, stablecoins provide a nice bit of stability to a market that is known for being volatile. Although stablecoins might not be the smartest move for long-term investors, they have their short-term uses, especially if the market is acting in a way that concerns you.
Stablecoins allow you to still keep your money in the market, but keep it in a safe asset that won’t move while everything changes around it.
Depending on who you are as an investor you may or may not have a use for stablecoins.