Stablecoins are a group of cryptocurrencies. Unlike regular cryptocurrencies though, their value is relatively stable and not subject to the wild volatility that characterizes the crypto industry, hence the name “stable” coins.
They have become very popular in recent times, as crypto payments have become popular due to the efficiency, low cost, and speed of such transactions. This is because like any other cryptocurrency, stablecoins are built on blockchain technology, so they possess all the characteristics of cryptocurrencies, except the volatility.
How stablecoins came about
Cryptocurrencies came into existence in 2009 with the launch of Bitcoin, which was itself designed to be an electronic peer-to-peer form of cash. However, Bitcoin and every other cryptocurrency after it fell short of the expectation of being cash, due to many reasons, one of which was volatility.
Crypto developers therefore came up with an idea to create a cryptocurrency that is relatively stable, with a fixed value, that can be used for payments. This was achieved by creating a cryptocurrency that is pegged to the value of a something else, like fiat currency such as the U.S. Dollar, Euro, or GBP.
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The first stablecoin, Tether’s USDT for example, is pegged to the U.S. Dollar. That means every USDT is backed by one USD, therefore the price is not expected to change as rapidly as that of a conventional cryptocurrency like Bitcoin.
USDT’s value stays roughly at 1 USD, and although the value may vary by a few cents, it is not expected to change more than that, unless for some reason, it de-pegs from the USD.
Types of stablecoins
All stablecoins have one thing in common – they’re pegged to something of more stable value. However, not all stablecoins are the same. The following are the most common types of stablecoins you’re likely to come across in the crypto space, based on where they derive value.
Fiat-backed stablecoins
These are stable coins that are backed by a fiat cryptocurrency. They are the most common class of stablecoins, backed by a currency such as the USD, EUR, or GBP. Each unit of the stablecoin is valued at roughly one unit of the currency it is pegged to. Examples are USDT and USDC, both pegged to the USD.
Commodity-backed stablecoins
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These are stablecoins backed by commodities. The value of the stablecoin is derived from a unit of the commodity that is backing it. Such commodities are gold, real estate, metals etc. Examples of commodity-backed stablecoins are Tether Gold and Paxos Gold, both backed by gold.
Crypto-backed stablecoins
These are stablecoins whose value derive from a cryptocurrency, rather than a fiat currency or commodity. An example is Wrapped Bitcoin (WBTC), an Ethereum-based stablecoin backed by Bitcoin.
Algorithmic stablecoins
While stablecoins are traditionally pegged to something of more stable value, some of them have more. Algorithm stablecoins are a category that uses algorithms to control the supply of the stablecoin in order to stabilize price, even though pegged to something. An example is Terra USD, a stablecoin issued by Terraform Labs.
Pros of stablecons
Stablecons have several advantages as a means of payment. The following are some of the advantages of using them.
Fast: because stablecoins are built on blockchain technology, they’re faster for payment than any fiat currency.
Cheap: stablecoins are not only fast for transactions, they’re also cheap.
Secure: payments with stablecoins are more secure than with fiat currencies, because of the security features that are inherent in blockchain technology.
Stable value: stablecoins are stable in value, unlike other cryptocurrencies, which makes them perfect for making payments
Cons of stablecoins
Stablecoins have several advantages, but they also have some weak points. The following are some of the weak points of stablecoins you should know about.
Centralization: there has been a heated argument that stablecoins such as USDT and USDC are quite centralized, unlike conventional cryptocurrencies such as Bitcoin. This makes them quite prone to manipulation
Risk of depegging: while it is a rare occurrence, stablecoins can potentially de-peg from whatever they are pegged to, leading to a rapid fall in its value, or an unusual increase in the same. The problem with TerraUSD in 2022 comes to mind in this case.
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