What is a stablecoin?

Stablecoin definition

Stablecoins are cryptocurrencies whose value is pegged to another asset, such as fiat currencies, an exchange-traded commodity, or another more established cryptocurrency. 

Stablecoins work just as other types of crypto coins or altcoins. They are digital assets built on blockchain technology that can be bought, sold, or traded on cryptocurrency exchanges.

What is the purpose of a stablecoin?

The key purpose of stablecoin is to mitigate the problem of volatility in crypto investments. As their value is often tied to a real-world asset, stablecoin issuers aim to provide buyers with a more stable value. 

Essentially, stablecoin owners enjoy the benefits of cryptocurrencies (such as decentralization and fast transactions) while also enjoying price stability similar to traditional currencies.

Why are stablecoins important?

Stablecoins represent a possible solution to maintain price stability for crypto holders. Unlike Bitcoin or Ethereum, whose prices can experience great fluctuations, stablecoins vouch to become a less volatile cryptocurrency and a more reliable medium of exchange.

More exciting, they could create a bridge between the traditional financial system and the crypto world. By offering price stability similar to fiat currencies, they open doors to interaction and integration between the two. Some stablecoins have shown faster transaction time, a feature that could support their use in the physical point of sale or e-commerce.

Which type of stablecoins exist?

There are 4 main types of stablecoins: fiat-backed, commodity-backed, crypto-backed, and algorithmic.

Fiat-backed stablecoins

Fiat-backed stablecoins are among the most popular stablecoins in existence. As the name suggests, their value is pegged to fiat currencies at a 1:1 ratio. In other words, the issuer has one stablecoin for every unit of the fiat currency (to which the stablecoin is pegged) in reserve.   

BitUSD (BITUSD) was the first stablecoin ever issued, pegged to the US Dollar. Since then, more and more fiat-backed stablecoins have been created, tying themselves to multiple currencies. Some mentionable fiat-pegged coins include:

• StablR (EURR) – backed by the Euro

• Circle (USDC) – backed by the US Dollar

• Anchored Coins (ACHF) – backed by the Swiss Franc

Commodity-backed stablecoins

Stablecoins whose value is tied to real-world commodities, such as gold and oil, or precious metals, such as silver or platinum, are called commodity-backed stablecoins. Compared to fiat-backed crypto, these stablecoins are an interesting way for investors to access different commodities, thus diversifying their investment portfolio.

A potential downside for commodity-pegged stablecoins is the price of the collateralized commodities, which can be higher than traditional currency. Some popular stablecoins of this kind are: 

• Tether Gold (XAUT) – backed by physical gold in vaults

• Paxos Gold (PAXG) – backed by physical gold in vaults

• Silver Token (SLVT) – backed by the price of silver

Crypto-backed stablecoins

Crypto-backed stablecoins use other cryptocurrencies as collateral to maintain a stable price. The collateralized cryptos, such as Ethereum or BitCoin, are usually established and relatively stable.

Crypto-pegged stablecoins are unique compared to other stablecoins in that they’re often over-collateralized. This means that there are more cryptocurrencies in reserves than available stablecoins. This is meant to safeguard stablecoin holders from the volatility of the underlying crypto.

Some crypto-backed stablecoins also employ smart contracts. These are self-executing codes on the blockchain that adjust the collateralization ratio as close to the peg as possible.

Algorithmic stablecoins

These coins use the same collaterals mentioned, but their values don’t necessarily depend on how many underlying assets are in reserves. This is because algorithmic stablecoins use algorithm-generated smart contracts to adjust supply and demand to maintain their price pegs.

For example, the algorithmic mechanism can increase the tokens’ supply if the price exceeds the peg. Conversely, it can decrease the supply if the price falls below the peg.

Possible disadvantages of stablecoins

Critics have voiced their concerns about certain drawbacks of stablecoins. Crypto-backed and algorithmic stablecoins have complex structures which require in-depth understanding before investment.

Moreover, due to the current lack of laws and regulations, stablecoin holders are subject to counterparty risks such as hacking and bankruptcy. Another mentionable risk is that stablecoin holders need to trust their reserve custodians to have adequate underlying assets. More and more issuers have made this process more transparent with a Proof of Reserve, which has partially solved the problem. However, lawmakers are working towards a more secure future for this $128 billion market. 

A brief history of stablecoins

The year 2014 marked the birth of the first fiat-backed stablecoin, BitUSD. In the same year, Tether launched USDT, another USD-pegged stablecoin. Early iterations often relied on a centralized model, where a company held reserves of the pegged fiat currency to back the value of each stablecoin issued. However, concerns about transparency and the true nature of these reserves remain.

Afterwards, decentralized stablecoins were created to address these concerns. MakerDAO’s Dai, launched in 2017, is a prime example. Dai is a crypto-backed stablecoin, where users deposit other cryptocurrencies as collateral to mint Dai tokens. Algorithmic stablecoins, another innovation, attempted to maintain the peg through algorithms that automatically adjust the supply of tokens based on market demand. TerraUSD (UST), launched in 2022, was a prominent example. 

However, a series of events in May 2022 caused UST to be de-pegged, highlighting the potential risks associated with this approach.

What lies in store for stablecoins

The future of stablecoins is exciting. These coins are projected to be the digital currency of the future as their users profit from the stability of the traditional financial system while benefiting from the decentralised nature of cryptocurrency.

Interoperability between stablecoins is also predicted to become more and more important. Currently, different stablecoins operate on different blockchains with their own protocols and standards, making it hard for them to communicate with each other. In the future, we might be able to use one stablecoin to pay for goods and services priced in another stablecoin.

New rules and regulations will also be introduced in the stablecoin market. Some focus areas for new laws might include reserve management, consumer protection, and market integrity. For example, regulators might specify which type of assets can be held in reserve, decide on a complaint mechanism for consumers, or migrate the risk of market manipulation through stablecoins. 

EURR stablecoin by StablR

StablR is a trusted issuer of Euro-backed stablecoins (EURR). StablR’s EURR uses a smart contract that allows you to create and manage tokens on the Ethereum blockchain using the ERC-20 standard. EURR transactions are secure and transparent, with minimized transaction fees.