Cryptocurrency is notoriously volatile, which reduces mainstream participation and limits its use (generally) as a usable platform of exchange for goods and services. The stablecoin is a low volatility version of a cryptocurrency. Reducing volatility can be achieved in a number of ways, including backing the coin with a stable asset.
Stablecoins are useful for investors who want to keep their assets in the crypto space. Switching from crypto to fiat currency can be expensive and time consuming. Stablecoins give investors the best of both worlds — a stable asset within the crypto space with an advantageous transactional speed.
Because of the relative stability, stablecoins also have an easier time staying in compliance with regulators. The Gemini Dollar (GUSD) and the Paxos Standard (PAX) are 2 examples of coins to win the regulatory approval of the New York State Department of Financial Services.
What is Stablecoin?
A stablecoin is a cryptocurrency that is meant to limit the volatility that investors experience when using crypto. Stablecoins are usually pegged to another asset with a stable value, but they may also be backed by an algorithm.
Consumers who are looking to buy or sell non-currency goods and services may experience a huge price change during or after the transaction. Stablecoins level the playing field without a need for either party to change back into fiat.
Stablecoins began to rise in popularity after the 2017 mania. After bitcoin rose to almost $20,000 then fell by more than 50%, investors were looking for a less volatile crypto based store of value. The success of crypto based coins led to the Federal Reserve to announce an investigation into its own digital coin along with the governments and central banks of other countries.
Types of Stablecoins
There are many different kinds of stablecoins, differentiated primarily by the asset that backs them. Here are the major types:
Commodity Backed Stablecoins
Commodity-backed stablecoins are stabilized with hard assets such as gold or real estate. The most commonly used asset to collateralize stablecoins is gold, although many use diversified baskets of precious metals.
Fiat Backed Stablecoins
Stablecoins backed by fiat currencies like Chinese yuan keep a reserve of that currency as collateral. Other forms of fiat include precious metals such as platinum or silver and commodities such as corn or oil.
Most fiat backed stablecoins are backed with dollar reserves. The reserve for the currency is administered through an independent custodian that is audited on a scheduled basis to ensure compliance.
Crypto Backed Stablecoins
Crypto can back other crypto as well. Such is the case with crypto backed stablecoins. To counteract the higher relative volatility of backing stablecoins through crypto, the coin will maintain an overcollateralized position.
In other words, the stablecoin will circulate a much lower supply against the reserve as compared to fiat backed currencies. For instance, a crypto backed stablecoin may issue only $500 worth of coins for every $2,000 of crypto in reserves rather than keeping a 1-to-1 ratio.
Siegniorage Style Stablecoins
Siegniorage are governed through and backed by an algorithm or process rather than another asset or currency. The idea of siegniorage as backing came from a whitepaper from noted cryptographer Robert Sams, who puts forward the idea of a Federal Reserve coin (fedcoin) that could function as such. Smart contracts deployed on decentralized platforms could serve as an autonomous “backer” for these kinds of coins.
The Best Stablecoins Right Now
Not all stablecoins are created equal. With the number of stablecoins growing, it is good to have a grasp of the most useful and well anchored choices. Here are the best stablecoins right now:
1. Tether (USDT)
So named because it “tethers” itself to the value of the USD, Tether is the most well-known stablecoin in the crypto world. It’s backed by gold, traditional currency and cash equivalents. Tether is also known for its security and smooth integration with crypto to fiat platforms.
2. True USD (TUSD)
True USD (also represented as “TrueUSD”) is 100% backed by the U.S. dollar and is 1 of the most liquid stablecoins on the market. The coin offers lower transaction fees than wire transfers of fiat currency and higher interest rates on stored balances. The company behind True USD, TrustToken, also has stablecoins pegged to other major currencies — TrueAUD, TrueGBP and TrueHKD, to name a few.
3. Paxos Standard (PAX)
Paxos Standard aims to keep 1:1 parity with the U.S. dollar. It was created as an answer to the Tether printing controversy, which saw Tether come under fire for an unverified claim that it held $1.8 billion with Deltec Bank & Trust Ltd to back its stablecoin.
4. USD Coin (USDC)
USD Coin is a stablecoin backed by Coinbase, the world’s biggest bitcoin broker and largest exchange holder of bitcoin.
5. Binance USD (BUSD)
Not to be outdone, crypto exchange Binance also released a Binance USD, which is pegged 1:1 to the U.S. dollar.
Every sophisticated crypto trading platform allows access to stablecoins alongside unpegged cryptocurrencies. Whether you are an active trader or a long term investor, having this tool available is a smart option for preserving wealth and stabilizing portfolio value. Here are a few of the best cryptocurrency exchanges to consider trading on:
Advantages vs. Disadvantages
Like any form of crypto, stablecoins come with a unique set of advantages and disadvantages.
- Borderless. Stablecoins retain the power of all cryptocurrencies to move without regard to physical borders.
- Transactional speed. Financial transactions on blockchains are objectively faster than traditional processes. Stablecoin transactions don’t have to wait on a 3rd party to verify the transfer, which means no one pays fees to any 3rd party either.
- Transparency. Transactions using stablecoins are recorded on a public ledger that can be monitored by anyone, unlike fiat currency.
- Centralization. Unlike some cryptocurrencies, stablecoins are mostly created by centralized organizations that own the currency. Even DAI, a well-respected stablecoin that markets itself as decentralized, has faced scrutiny for its centralized organization.
- Requires 3rd party audits. Stablecoins must be audited through 3rd parties that may create conflicts of interest to a decentralized, trustless or pseudonymous experience.
- Less growth. Stablecoins don’t provide the potential for high ROIs to investors like unpegged cryptocurrencies.
Using Stability to Create Profitability
Most crypto investors would probably agree that having a stablecoin or 2 in your portfolio is a good way to diversify and protect yourself. If you are actively trading volatile alt coins, you can also use the stablecoin to move quickly out of falling assets and repurchase at a better price.
Will the stablecoin completely disrupt the crypto space? A complete takeover is unlikely because the purpose of the stablecoin and the unpegged cryptocurrency are 2 different things.
A more likely scenario is that stablecoins serve as another financial vehicle in the digital transformation of money. Stablecoins can provide liquidity to markets of exchange, serve as a medium of exchange for risk averse investors and protect physical assets in the digital realm.
Frequently Asked Questions
Q: How is virtual currency treated for federal income tax purposes?
Virtual currency is treated as property and general tax principles applicable to property transactions apply to transactions using virtual currency.
Q: How many different cryptocurrencies exist?
There is no exact number of existing cryptocurrencies because the code of the cryptocurrency is an open source. This means anyone can create their own version of cryptocurrency by just using the code.
It’s estimated there more than 900 cryptocurrencies on the market.
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