What are stablecoins?

Brief summary

✔️ Stablecoins are digital currencies designed to maintain a stable value.

✔️ Stablecoins facilitate cryptocurrency trading, you can trade almost anywhere with them.

✔️ With stablecoins you can generate interest or other income in various places, unlike fiat money on which you get little to no interest.

✔️ You have different types of stablecoins, namely stablecoins backed by fiat money and stablecoins backed by collateral.

Forms of stablecoins

Stablecoins are cryptocurrencies that should represent a stable value. Almost always they do, but there have been times, even with very large and well-known stablecoins like USDT, that they were worth less than what they purported to represent.

For example, you have coins that represent the dollar in cryptocurrency form. Well-known examples are USDT, USDC and BUSD. The value should be almost exactly the same as a dollar.

There are several forms of stablecoins that value in fiat money expressed represent. The dollar is by far the most popular currency to be expressed in stablecoin, although the euro is making a small advance with the Euro Tether and the STASIS EURO. However, there is much less trading in these so far. It can be expected that for every major and important currency there will be or already is a crypto equivalent on the market.

There are also stablecoins that represent another type of value, such as gold and other precious metals, commodities or another cryptocurrency.

All stablecoins are kept in a ledger called the blockchain.

What are stablecoins used for?

If you start trading cryptocurrency, you can pay with stablecoins almost anywhere. This is a big advantage over, say, fiat money. With fiat money you can pay in many places, but not everywhere. Stablecoins facilitate cryptocurrency trading.

There is another reason people exchange fiat money for stablecoins. On stablecoins you get interest or other income in all sorts of places, whereas on fiat money you get little to no interest.

Key features stablecoins

Another very important function of stablecoins is their stability. They are always worth (in theory) approximately what they represent. 1 Tether is 1 dollar. In times when cryptocurrencies lose their value, the bear market, stablecoins ensure that you yourself do not lose value if all your money is in stablecoins.

Another use value of stablecoins is that you can trade with them around the world. If you carry a bag of euros you often have to exchange it to the local currency first, but if you have stablecoin you can trade across borders without exchanging, provided they accept Tether, for example, as payment.

Stablecoins and taxes

In many countries, you have to pay taxes if you exchange cryptocurrency for fiat money. This does not apply to stablecoins. So you can avoid taxes by holding your capital in stablecoins. This capital is also easy to send between exchanges and wallets, if necessary.

Other possibilities with stablecoins

Sometimes people use stablecoins as collateral for a loan in fiat money. Through a smart contract, you can thus avoid the usual financial institutions that ask for money for it and start checking your creditworthiness.

An exceptional situation for the use of stablecoins occurs when a particular currency faces a hyperinflation. Fiat money is then worth nothing, but if you still have stablecoins in your possession you could pay for things with them, if the seller agrees.

How does stablecoin work?

There are various forms of stablecoins and they also work in different ways.

Fiat stablecoins: USDC

The USDC, an ERC-20 token on the Ethereum blockchain, is in theory fully backed by giro money. We say in theory, because there can be a difference between what stablecoin issuers say and how it really is. So the USDC is fully backed by fiat money, which is not used for anything but covering the USDC. A regular audit should ensure that no more USDC is put on the market than there is money in this account. This is considered the most secure stablecoin for this reason. It is a partnership between Coinbase and Circle. It is an Ethereum coin though, so if you plan to ship it to another address you have to factor in ETH gas fees.

USDT

The USDT is covered 70% in this way. The rest is covered by US government bonds and other securities. So this coin is riskier to put your money in. There was a time when the USDT, also known as Tether, was worth less than a dollar. In 2018, the price dropped to 85 US cents, due to suspicions of shadowy structures between Bitfinex and Tether. After that, they regained firm control and the coin is once again worth the dollar it represents.

BUSD

The last fiat stablecoin I will briefly discuss is the Binance USD, BUSD. It has always remained stable and is therefore backed by the largest exchange in the world, Binance. Trust in Binance is high and therefore it is considered very safe.

CBDC

Banks are also eager to issue stablecoin under the name CBDC (Central Bank Digital Currency). They probably recognize that the crypto market and the blockchain has great advantages that fiat money does not have. Many people do fear for their privacy if everything they buy is recorded on the blockchain. I assume the banks won't make it a publicly viewable ledger.

Complex coverage of a stablecoin

Some stablecoins have a complicated hedging system, where fluctuations in their value are hedged by other coins or by buyback schemes. In general, the more complicated the system is put together, the faster things can go wrong.

For example, you saw with Terra's UST that the value of their UST plummeted within no time. This stablecoin used an algorithm, which in theory guaranteed stability, in that when the value went up, people would sell their stablecoins until the stablecoin was back at $1 and vice versa. However, a smart UST whale had put his big bag of UST on the market and gone short on Terra Luna. Terra Luna still tried to stop the decline in value by injecting their collateral, the coin Terra Luna, but to no avail. The downward spiral was unstoppable and UST dropped tremendously in value. Within a month, it was decided.

Collateral stablecoins

PM or Precious Metal stablecoins represent a value that should be 1 to 1 with the value of usually gold or silver against a fiat currency. Well-known forms of these are PAX GOLD or Tether Gold. The question with these types of coins should always be whether the cover is really there in the form of real gold in a vault.

There can be lots of types of collateral in asset-backed cryptocurrencies. In fact, you can't think of anything or it can be done. Real estate, major cryptocurrency, commodities, in-game items, you can have anything serve as collateral. Whether it is smart to invest in these stablecoins is another question. Why be difficult when it can be easy? The goal is to provide stability, right? Then a fiat currency as collateral seems fine to me.

There are also Sovereign backed stablecoins. These are cryptocurrencies issued by a country or company where the government guarantees their value. Usually these are small sovereign or island states like the Virgin Islands or El Salvador.

Advantages of stablecoins

1. Protect your money in value. If you still have cryptocurrencies in a bear market they drop in value, while stablecoins retain their value.

2. Trading quickly around the world. Trading with fiat money around the world can be a disaster, including financially. Stablecoins can be exchanged very easily instantaneously without intermediaries and at very low cost.

3. Your stablecoins are not linked to your name, ensuring your privacy.

4. You can lend stablecoins at interest or receive interest on them directly by staking. This way you can absorb inflation.

5. You can redeem stablecoins for virtually any cryptocurrency.

6. Day trading is much easier.

7. Sending crypto to another exchange is easy with stablecoins.

8. Tax dodge by not converting to fiat money.

9. Stablecoins are on a blockchain. This gives you all the advantages that come with a blockchain without the disadvantages of money in a bank. For example, low cost per transaction, speed, privacy, corruption of employees when exchanging is impossible since it is decentralized, irreversibility of a transaction.

10. Working with smart contracts to reduce cost of doing business.

11. Access to finance for people without bank accounts.

Disadvantages of stablecoins

1. They are not volatile. That is, your money is still worth the same over years in fiat money terms. Therefore, you cannot profit from price increases and it is therefore not an investment.

2. They are still linked to fiat money, so if the value of underlying fiat money decreases, so do your stablecoins.

3. Some stablecoins are created by a commercial company. This company must then have a good foundation or cover for the stablecoin, otherwise it may collapse. You then have to trust that they have enough reserves.

4. With a bug in the programming of an in theory stable coin, fluctuations can occur when smart people take advantage of the loopholes.

5. The value can still fluctuate as with an algorithm to maintain value.

6. You don't have insurance like deposit insurance.

7. If a company coins stablecoins, you just have to trust that this company will keep your funds safe.

8. Certain tech companies can gain a lot of power by issuing stablecoins.