If you tend to keep an eye on cryptocurrency like Bitcoin or Ethereum, you’ll notice the value of most of these digital currencies tend to fluctuate with much volatility. In other words these cryptocurrencies are notoriously unstable. This is where stablecoins come in. As its name suggests, they are a specialized class of cryptocurrencies that hold some value. Many stablecoins are fixed to a particular type of fiat currency or currency that is widely in use such as the US dollar, Euro, or gold.
What’s Their Purpose?
One of the beauties of investing is the idea that one can make a return on their investment. This also comes with the added risk that one can also lose money if the value of the investment decreases. Because cryptocurrencies like Bitcoin for example are so volatile there became a need for more stable cryptocurrencies. Since the value of Stablecoins are pegged at fiat currencies like the US Dollar, traders can be confident that their investment will hold its value albeit they probably won’t make any returns.
When entering a bear market stablecoins can be particularly useful. A bear market occurs when crypto or any other asset for that matter goes into a steep and steady decline. Instead of losing value on any returns they may have made, traders can take assets within their portfolio and purchase fixed stablecoins instead. This also comes with the added benefit of not having to lose any money when converting cryptocurrencies to fiat currency. Typically when a trader or investor decides to cash out their assets the exchange platform they’re using may incur fees.
Types Of Stablecoins
It is important to note that there are various types of stablecoins. The first type would be fiat based, which we already described above. This is crypto that is collateralized by fiat currency such as the US dollar or the Euro.
These stablecoins are backed by a combination of other cryptocurrencies. They are having difficult time gaining traction due to their complexity. An over simplistic example would be let’s say someone wants to purchase 500 dollars worth of Stablecoins. They would first have to have a 1000 dollars worth of another cryptocurrency like Bitcoin for example, then use the Bitcoin to purchase stablecoins. The idea behind it is the stablecoins that were purchased are over collateralized in order to endure price fluctuations.
This crypto is backed by a physical asset such as gold, precious metals, or real estate. One popular commodity based cryptocurrency is called Digix (DGX). This crypto is backed by bars of gold. They claim to be transparent and operate on the Blockchain like many other cryptocurrencies. They have vaults in Singapore and Canada where they claim to have the bars of gold stored which are supposedly audited at regular intervals for transparency.
Interestingly enough, these coins aren’t really backed by anything. This type of crypto is similar to fiat based stablecoins wherein the price is driven by supply and demand, however the supply is based on an algorithm instead of an asset. NuBits (USNBT) is an example of this type of stablecoin. It was originally intended to have a value similar to that of the US dollar. The idea behind it is traders receive voting shares which they then use to vote on and control the network. To avoid pricing fluctuations, NuBits was able to be pegged at another cryptocurrency. Unfortunately Nubits failed to maintain its value.
Although many Stablecoins exist, one of the most popular ones to date would be Tether. Tether, just like many other cryptocurrencies, operates on the Blockchain and claims to be backed by the US Dollar. Tether is subject to inflations that impact the US Dollar but typically they are so small it makes it perfect for day to day transactions.
In the past few years Tether Limited, the company behind Tether has been criticized for Bitcoin price manipulation and for the cryptocurrency not actually maintaining its value. Many considered this to be controversial because the company failed to show that it actually had the adequate reserves to back each and every USDT (Tether coin). Without the adequate reserves there would then be unbacked Tether coins getting pushed into the market which would elevate other cryptocurrency prices such as Bitcoin.
Stablecoins definitely have their uses in the cryptocurrency market. We can see they’re advantageous in some situations and can save traders money during bear markets. It’s important for traders to be aware of the various types of stablecoins that exist and it may also be worth taking the time to look into the company behind the crypto before making any investment decisions.