Stablecoins: A Back-to-the-Basics Review

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In simple terms, Stablecoins are digital currencies with a peg to a more stable asset, like fiat currencies and commodities.

Now, you may be tempted to ask: “why not just use a more stable asset, like the dollar, instead of using a Stablecoin?” To answer this question, we need to look at a few critical roles Stablecoins play in the digital economy.

Importance of Stablecoins

Stablecoins have a quicker and easier conversion ability. Imagine having to convert from fiat every time you need to make a crypto investment or transaction.

Stablecoins are a safe and secure option for harboring your crypto investment. Investing in any other digital asset is significantly riskier compared to holding Stablecoins. As the name suggests, they are not susceptible to erratic price swings or rapid devaluation.

Stablecoins are the “on-ramp” and “off-ramp” to the digital economy. These assets are a connector between the “traditional economy” and the “digital economy.”

Stablecoins offer a much better interest rate for your holdings than regular fiat. Compared to keeping your money in the bank, Stablecoins can offer 100 times the “yield.” Most banks offer an annual interest rate of 0.6% on your deposit, while Stablecoins offer as high as 6%.

Without a doubt, Stablecoins can be valuable investments while offering meaningful utility. Nonetheless, they offer significantly lower yields, as a trade-off, compared to other cryptocurrencies.

Classes of Stablecoins

As mentioned earlier, Stablecoins are backed by a relatively stable assets, like the US dollar, euro, gold, and even other cryptocurrencies. That said, this difference in pegged assets translates as a risk factor for Stablecoin. Essentially, the riskier the pegged asset, the more volatile and risk-inclined the Stablecoin.

Generally, fiat-backed Stablecoins are regarded as the safest and “best” of the Stablecoin class. With this class, every issued token, for instance, is backed by the fiat equivalent.

Some of the most popular fiat-backed Stablecoins include Tether (USDT), USD Coin (USDC), and TerraUSD (UST).

Commodity-backed Stablecoins, digital assets backed by real-world assets like gold and silver, are the second most-stable tokens. In this case, every issued token is backed by the dollar equivalent I’m gold, for example. These digital assets are best for times of extreme financial uncertainty when most investors troop into commodities.

Some popular commodity-backed Stablecoins include Tether Gold (XAUT) and Paxos Gold (PAXG).

We also have the crypto-backed Stablecoins, which are essentially backed by several other cryptocurrencies. While relatively more stable than the typical crypto asset, this digital asset class holds significant risk considering they are entirely tied to the crypto market.

The most well-known of this digital asset is Dai (DAI).

Finally, we have the algorithmic Stablecoins. Unlike other counterparts, algorithmic-backed tokens are not supported by tangible assets but by complicated computer algorithms to sustain their stability. This means that such digital assets rely entirely on the computer code for their existence, making it the riskiest Stablecoin on our list.

Nonetheless, all Stablecoins share some similar risks, including regulation, inflation, and the possibility of losing their peg.

 

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Azeez Mustapha

Azeez Mustapha is a trading professional, currency analyst, signals strategist, and funds manager with over ten years of experience within the financial field. As a blogger and finance author, he helps investors understand complex financial concepts, improve their investing skills, and learn how to manage their money.