What are Stablecoins and How Do They Work? | Bitbuy Canada

What Are Stablecoins, and How Do They Work?

The world has gone crypto.

Nowadays, premier coins, stablecoins, memecoins, altcoins, and digital currency are all the rage.

It seems like everyone has contracted the FOMO for Bitcoin, Ethereum, Shiba Coin, Dogecoin, and, if you have been paying attention to McDonald’s Twitter account, Grimacecoin.

Despite the notable corrections that have occurred since hitting record highs in the summer of 2021, the cryptocurrency market still possesses a value of about $2 trillion. With thousands of digital tokens to choose from, and many protocols aiming to solve industry problems, investors have a large variety to select and add to their portfolios.

Of course, in this inflationary environment and when factoring in the decline in the broader cryptocurrency market, traders might desire to purchase stablecoins. This strategy aims to preserve their purchasing power and protect their portfolio from the quantitative tightening campaigns engaged by central banks worldwide.

Wait a minute.

Stablecoin?

What is a Stablecoin?

The name makes it seem like an attractive investment to hedge against external market forces, whether inflation or a market downturn. Let’s learn more!

What Are Stablecoins?

A stablecoin is a group of cryptocurrencies with the objective of extending price stability to holders. These cryptocurrencies are backed by an external reserve asset, such as gold, other precious metals, or the United States dollar.

In recent years, stablecoins have become quite popular since they provide traders everything that makes crypto appealing, like instant processing and the security of transactions. At the same time, a stablecoin offers zero volatility like some of its brethren in the virtual currency ecosystem.

Today, there are dozens of stablecoins to invest in. Here are the top ten based on market capitalization:

  • Tether (USDT)
  • USD Coin (USDC)
  • Binance USD (BUSD)
  • TerraUSD (UST)
  • Dai (DAI)
  • TrueUSD (TUSD)
  • Pax Dollar (USDP)
  • Neutrino USD (USDN)
  • Feu USD (FEI)
  • Tribe (TRIBE)

Moreover, if you have an affinity for the gold standard, the precious metal-supported currency, Digix Gold Token (GDX), is essentially the digital version of this monetary system. Each coin’s value is tied to the value of gold, so each DGX represents one gram of gold.

Are There Different Types of Stablecoins?

Now that you know the popular stablecoins, you should familiarize yourself with the three different types of stablecoins.

Fiat-Collateralized Stablecoins

Fiat-backed stablecoins contain a fiat currency as their chief reserve, such as the U.S. dollar or euro, as collateral to invest with crypto coins. These reserves are monitored by independent custodians and receive routine audits, so the tokens adhere to required compliance.

Non-Collateralized Stablecoins

Non-collateralized stablecoins are not backed by any reserves at all. Instead, this type of coin will install a public policy or mechanism, much like a central bank. For example, a stablecoin might utilize a consensus to determine if the supply of the token should be increased or decreased. This, in theory, offers holders a stable price.

Crypto-Collateralized Stablecoins

Crypto-collateralized stablecoins are backed by other cryptocurrencies, making stablecoins potentially over-collateralized. But would this not make the stablecoin extremely volatile? Not exactly. The reason is that there may be a more significant number of cryptocurrency tokens that are in reserves in exchange for issuing a smaller number of coins.

Will Regulations Come for Stablecoins?

This does not mean stablecoins are perfect and are guaranteed to shield you from financial ruin.

Consider this explanation from Coindesk in December 2020: “In the worst-case scenario, it’s possible the reserves backing a stablecoin could turn out to be insufficient to redeem every unit, potentially shaking confidence in the coin.”

Despite their stable nature – hence the name – the virtual token has been heavily scrutinized by regulators and crypto enthusiasts. They have justified this position by citing the more than $130 billion market and the coin’s immense impact on the broader international financial system.

Even government officials have demanded consistent oversight and regulation for stablecoin issuers.

Although she is an advocate of cryptocurrency, Senator Cynthia Lummis (R-WY) stated in September 2021 that stablecoins need to “be audited regularly” and “in a transparent manner.”

A month later, the International Organization of Securities Commissions (IOSCO) proposed rigorous regulations because it often serves alongside payment systems and clearinghouses.

Recently, a report from the President’s Working Group on Financial Markets, the Federal Deposit Insurance Corporation (FDIC), and the Office of the Comptroller of the Currency stated:

“If well-designed and appropriately regulated, stablecoins could support faster, more efficient, and more inclusive payments options. Moreover, the transition to broader use of stablecoins as a means of payment could occur rapidly due to network effects or relationships between stablecoins and existing user bases or platforms.”

This has become the consensus across most of the developed world: cryptocurrency, whether it is a stablecoin or a premier token, can be a great addition to the financial markets, but it needs regulation.

The British government recently funded research and development grants to study stablecoins and central bank digital currencies (CBDCs).

The Bank of England and Her Majesty’s Treasury announced in November that they would be looking into launching a digital pound. They have joined other jurisdictions in making this consideration, including the United States, Canada, Australia, Mexico, and China.

China has been one of the first major markets to embrace digital money, resulting in billions of dollars worth of transactions. This might have been the reason for its crackdown on cryptocurrency mining, trading, and transactions and prohibiting financial institutions from engaging in this industry.

Will Stablecoins Save Crypto?

The unpredictability and intense volatility of cryptocurrency have been drawbacks for many investors – retail and institutional – who have been sitting on the sidelines over the last decade.

Bitcoin can surge $1,200 in one session and fall $1,300 the next day. Ethereum, the world’s second-largest cryptocurrency, has endured the same level of instability: Up $800 on Monday and down $950 on Tuesday.

Similar to how Cardano is trying to improve smart contracts or how Dogecoin is attempting to support micropayments, the goal of stablecoins is to function like a Treasury note, bullion, or the greenback in giving a layer of security to the overall investment portfolio.

Ultimately, because the crypto industry is immense and diverse, you can also invest in speculative crypto assets (Shiba Army), value tokens (Bitcoin), and stablecoins (Dai). The world is your oyster.

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