Bitcoin and nearly all other cryptocurrencies are infamously volatile, capable of dramatic price swings.
While this is an attractive feature for speculators looking to profit from price movements, it also remains one of the biggest barriers to the widespread adoption and legitimacy of cryptocurrency.
Enter stablecoins.
These fixed-price digital currencies provide stability and enable a variety of use cases that other cryptocurrencies may be unsuitable for.
Stablecoins are now a multi-billion dollar asset and help facilitate a lot of the crypto industry's economic and trading activity.
A stablecoin is the name given to any cryptocurrency that is designed to have a fixed price.
While the price of most cryptocurrencies (like Bitcoin) is determined by supply and demand, stablecoins are designed to maintain a constant, stable price.
The most common method stablecoins use to achieve this price stability is to peg the value of the coin to a real-world asset such as gold or the US dollar.
However, there are also a couple of other approaches for designing stablecoins, and we’ll explore all the options in detail a little further down the page.
This is a list of the 10 biggest stablecoins by market capitalisation1. All stablecoins on this list are pegged to the US dollar, apart from Tether Gold, which is instead pegged to the price of gold.
| Response | WA | VIC | SA | QLD | NSW |
|---|---|---|---|---|---|
| No | 75.49% | 63.12% | 56.16% | 72.86% | 72.21% |
| Yes - For long-term growth | 19.61% | 25.86% | 27.4% | 17.59% | 20.24% |
| Yes - for day trading | 2.94% | 4.56% | 8.22% | 4.52% | 1.81% |
| Yes - for short-term growth | 2.94% | 9.89% | 13.7% | 7.04% | 7.55% |
| Yes - as a hedge against AUD or central bank currencies | 1.96% | 1.14% | 1.01% | 1.51% | |
| Yes - to use it with blockchain application | 1.9% | 2.74% | 1.51% | 0.91% |
The most popular and straightforward type of stablecoin, fiat-backed stablecoins are supported by a real-world currency, most commonly the US dollar or other fiat currency.
That asset is owned and held by a central entity, with each unit of the stablecoin backed by a corresponding unit of the fiat currency.
For example, this means a US dollar stablecoin issuer would accept deposits in USD and issues one unit of its stablecoin for every dollar it receives.
If you decide you want to cash out 1,000 units of the stablecoin, the coin issuer transfers you US$1,000 and then “burns” 1,000 stablecoins, removing them from existence.
While this method is reasonably easy to understand and implement, its main downside is that it requires a high level of trust in the central entity that controls USD deposits and issues the stablecoin.
Despite being the largest stablecoin, Tether has long been the subject of accusations that not only is it used to prop up the price of Bitcoin. Critics have also claimed that the company behind the currency (Tether Limited) doesn’t have sufficient USD reserves to back up the supply of Tether, but this has never been successfully demonstrated.
Pros and cons of fiat-collateralised stablecoins
Pros
Cons
The concept of crypto-collateralised stablecoins is fairly similar to that of fiat-collateralised stablecoins, but with the obvious difference that they’re backed by digital currency (or a basket of digital currencies).
They also need to account for the volatility of the cryptocurrency being offered as collateral. So while fiat-collateralised coins are backed on a 1:1 ratio by fiat deposits, crypto-backed stablecoin issuers hold crypto deposits of a ratio higher than 1:1. For example, you may need to deposit $500 worth of Ether (ETH) to access $250 worth of a stablecoin.
Because crypto-backed coins can be managed on-chain, there’s no need to worry about entrusting your deposit to a third party. However, the biggest concern is the volatility of the underlying collateral, so the coin issuer must hold a substantial amount of collateral to protect against significant price drops.
Pros and cons of crypto-collateralised stablecoins
Pros
Cons
Seigniorage stablecoins are controlled by an algorithm designed to match supply with demand in order to achieve price stability. Using smart contracts, supply is increased when the coin’s price goes up and decreased when it goes down, thereby maintaining the stablecoin's price at a steady level.
For example, if the price of the stablecoin is trading at above $1 per unit, the algorithm issues additional units to increase overall supply until the price returns to $1. The profits collected in this process are known as seigniorage.
If the price falls below the $1 mark, the algorithm is designed to use seigniorage to buy up some of the coins, thereby decreasing supply and pushing the price back up to $1. If the price is still below $1 and there are no more profits left to buy more of the coin’s supply, seigniorage shares are issued. These are basically bonds that raise funds for the coin issuer and promise future seigniorage profits to buyers.
While they still exist, the collapse of Terra Luna, arguably the leading seignorage-based stablecoin project, in 2022 proved extremely damaging to the reputation of this type of stablecoin.2
Pros and cons of seigniorage stablecoins
Pros
Cons
While Satoshi Nakamoto’s vision for Bitcoin was as a form of electronic cash, the world’s biggest cryptocurrency is rarely used as a medium of exchange on a day-to-day basis. Rather, its volatility and high fees mean that Bitcoin is impractical for everyday transactions, and is instead used more as a store of value.
The same can be said for most other digital currencies. Because prices fluctuate significantly from one day to the next, holding and using crypto in the same way you do Australian dollars (getting paid a salary, paying for groceries, buying a coffee etc) simply isn’t viable. Think about it – why would a business accept Bitcoin as payment when 1 BTC might be worth $10,000 today, but tomorrow its value could have dropped to $9,000?
And this is, in theory at least, where stablecoins offer a key advantage. Not only do they offer all the benefits of cryptocurrency, including cryptographic security and the ability to transfer value digitally, but they’re designed to have the low volatility for which fiat currency is famous. The end result is a digital currency that can theoretically be used as a daily medium of exchange in the real world.
What can stablecoins be used for? A price-stable cryptocurrency could potentially have a wide range of purposes, including:
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There’s little doubt that a working, trusted stablecoin is a key stepping stone on cryptocurrency’s path to mainstream acceptance. However, this goal is still some way off.
There have been numerous examples in recent years of stablecoin projects that have simply failed to stand the test of time. Even Tether, the world’s largest (in terms of market cap) stablecoin and one that’s been around since 2015, has been plagued by accusations that it doesn’t have sufficient US dollar reserves to back up the amount of USDT in circulation.
While some stablecoins have been able to demonstrate short-term stability, only time will tell whether they can provide long-term reliability. Until that happens, don’t assume that any cryptocurrency will be able to provide the same stability as good old-fashioned fiat currency. And if you’re thinking of putting any of your hard-earned cash into a stablecoin project, make sure you thoroughly research it first.
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