What are stablecoins?

Key indicators

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

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

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

✔️ You have different types of stablecoins, namely fiat-backed stablecoins and collateralized stablecoins.

About stablecoins

Stablecoins are cryptocurrency that are supposed to represent a stable value. Most of the time they do, but there have been times, even with very large and well-known stablecoins like USDT, when they were worth less than what they were supposed 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 worth almost exactly the same as a dollar.

There are several forms of stablecoins that represent the value in fiat money. 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, much less is being traded 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 are going to trade cryptocurrency, you can pay with stablecoins almost anywhere. This is a big advantage over fiat money, for example. You can pay with fiat money in many places, but not everywhere. Stablecoins make trading cryptocurrency easier.

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

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 don't lose value yourself if all your money is in stablecoins.

Another use value of stablecoins is that you can trade with them all over 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, assuming they accept Tether, for example, as payment.

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.

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

An exceptional situation for using stablecoins occurs when a particular currency experiences hyperinflation. Fiat money will no longer be worth anything, 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 different forms of stablecoins and they also work in different ways.

Fiat stablecoins

The USDC, an ERC-20 token on the Ethereum blockchain, is in theory fully backed by cashless money. I say in theory because there can be a difference between what stablecoin providers say and how it really is. So the USDC is fully backed by fiat money, which is not used for anything but to back 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 send it to another address you have to consider ETH gas fees.

The USDT is covered 70% 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 shady structures between Bitfinex and Tether. They then managed to regain firm control and the coin is once again worth the dollar it represents.

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.

Banks are also eager to issue a stablecoin under the name CBDC (Central Bank Digital Currency). They probably recognize that the crypto market and 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 will not make it a publicly viewable ledger.

Some stablecoins have a complicated hedging system, where fluctuations in their value are hedged by other coins or 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 crashed 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 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 it was chanceless. The downward spiral was unstoppable and UST fell dramatically in value. Within a month it was all 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 this are PAX GOLD or Tether Gold. The question with these types of coins should always be whether the cover is actually present in the form of real gold in a vault.

There can be lots of types of collateral with 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. But why make it 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. Fast trading around the world. Trading around the world with fiat money 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 allows you to 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. Avoid taxes because you don't convert to fiat money.

9. Stablecoins are on a blockchain. This gives you all the advantages of 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 trading.

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. Thus, 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 made 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. A bug in the programming of a theoretically stable coin can cause fluctuations if smart people take advantage of the loopholes.

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

6. You have no insurance like deposit insurance.

7. If a company mints 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.