When it comes to cryptocurrencies, let's be honest: You can't ride a roller coaster without digging your nails into the armrests. One day your Bitcoin investment might buy you a Tesla, but the next day you'll wonder if you can afford to eat lunch. The “silver bullet” of the crypto world – stablecoins. These digital assets can help bring some stability to a volatile situation. What are they? Why are they so important? We'll explain them in detail.
What is a stablecoin?
Stablecoins seek to peg the value of a cryptocurrency to a stable reference asset such as the US dollar, euro, or gold. They are reliable friends who always keep the group together. There are three types of stablecoins currently in circulation:
The most common are fiat collateral (backed by reserves against traditional currencies), cryptocurrency collateral (backed by other cryptocurrencies). Algorithms (regulated by smart contracts).
Stablecoins, like their fiat-backed counterparts (such as Tether (USDT) and USD Coin (USDC)), are often operated with bank account reserves. Let's take a USDC usage example. While USDC reserves are regularly audited, Circle, as the issuer of USDC, reports monthly on assets set aside by USDC. All options, including crypto-backed options like DAI, require more collateral than the option requires, providing some kind of safety net if the underlying market declines.
Why is stability important in cryptocurrencies?
The volatility of the cryptocurrency market is a well-known fact. For example, imagine Bitcoin. Fluctuations of 20% can occur in a single day. For example, in 2021 alone, the price of Bitcoin fluctuated between $29,000 and more than $68,000. This rollercoaster nature makes it difficult for businesses and people to use cryptocurrencies for everyday transactions. What if you buy a coffee with Bitcoin, but by the time you get your latte, the coffee is worth half or twice (or even less)? This makes cryptocurrencies unreliable as a medium of exchange due to their unpredictability.
This problem is solved by stablecoins that provide predictability. Because they are anchored in stable assets, they can be used not only as a secure medium of exchange but also as a store of value. This is especially important in remittances, micropayments and e-commerce, where prices need to be stable. Stablecoins in the cryptocurrency market are popular because they reduce the damage caused by volatility during online games and apps that can affect the user experience when prices fluctuate rapidly. These are not just digital currencies, they are digital currencies that can be deposited in banks.
Bridging traditional finance and cryptocurrencies
Stablecoins are like crypto diplomats, or ambassadors of the crypto world, bridging the gap between cryptocurrencies (DeFi and TradFi). For example, it allows for a smoother transition from fiat to cryptocurrencies because people don't lose money due to price fluctuations.
In addition to this, decentralized finance stablecoins are also used in exchanges (DEXs) and lending platforms. These assets will become the primary liquidity provider for crypto exchanges by 2023, with trading volume on exchanges exceeding $3 trillion. These are critical to the liquidity pools and lending mechanisms of DeFi protocols such as Uniswap and Save. This is because users can trade and borrow on these platforms without the risk of significant value loss. Stablecoins are also integrated into traditional banking. The lines between traditional and blockchain-based payment systems are becoming even more blurred, with companies like Visa and Mastercard starting to allow transactions with USDC. The convenience of this hybrid approach also means mainstream acceptance.
Development lifeline
Stablecoins provide a lifeline to local currencies that are unstable due to things like hyperinflation and economic crises. Stablecoins allow people to preserve their wealth and provide access to the full functionality of the world's curated financial systems. The most recent example is Venezuela, whose citizens had no choice but to rely on USDT to overcome economic instability and sanctions.
Purchasing power can be quickly eroded by hyperinflation, with inflation rates reaching triple digits in Zimbabwe and Argentina. The solution lies in converting local currencies into stablecoins to save local Lira and expand to international markets. When it comes to emerging markets, Chainalysis conducted a study showing that over 50% of transactions in the cryptocurrency space in emerging markets involve stablecoins.
Many beneficiaries benefit from global remittances. According to the World Bank, remittance fees average 6% worldwide, costing migrant workers billions of dollars a year. In doing so, stablecoins can significantly reduce these costs and make it more than affordable for people to send money to their families. Transaction fees as low as a few cents are rewriting the history of cross-border mechanisms for stablecoins in international payments.
risks and controversy
On the other hand, crypto stablecoins have certain flaws, which is normal since nothing is perfect, right? Fiat-backed assets like Tether are often questioned as to whether there are sufficient reserves to back claims. Tether came under fire in 2021 after being accused of misrepresenting its reserves, but Tether settled with the U.S. Commodity Futures Trading Commission for $41 million.
Risks also exist with algorithmic stablecoins. Remember TerraUSD (UST)? The 2022 wipeout took away $40 billion in market capitalization when it collapsed, leaving investors reeling. This incident exposed the vulnerability of a model that relies too heavily on market trends that are not mitigated by safeguards. And now regulators around the world are paying close attention, with regulations such as the European Union's MiCA and the US's SEC Guidelines requiring increased compliance.
The future of stablecoins
One of the issues raised on both sides of the debate is that stablecoins could play a very influential role in evolving the role of central banks in launching digital currencies (CBDCs). That's true. Private ones could be directly replaced by CBDCs. But they have first-mover advantage and have stayed in DeFi for a long time. Moreover, the use cases for stablecoins will further expand. Stablecoins are carving out a permanent niche in the financial landscape, not only for gaming and tokenized assets, but also in areas such as international trade. As an example, it is increasingly used in smart contracts for automated payments and as collateral in DeFi lending platforms. What makes them essential is their ability to combine the best of all: the stability of traditional assets and the flexibility of blockchain.
As adoption increases, we may even see stablecoins integrated into everyday sectors such as real estate, healthcare, and entertainment. For example, casinos that accept cryptocurrencies have adopted stablecoins and moved to introduce them to allow users to enjoy secure and easy transactions.
conclusion
Stablecoins can be said to be a calm eye in the midst of a cryptocurrency hurricane. Today, they are the basis of ecosystems ranging from simple everyday transactions to cross-border payments and DeFi. But it also comes with risks. That is why stablecoin transparency and regulation are so important to stablecoin growth. Stablecoins will play an important role in the evolution of the cryptocurrency space. Whether you're a veteran of the cryptocurrency industry or just a curious beginner, now is a good time to take a look at stablecoins. why? In the Wild West, a little stability goes a long way. That's called a cipher.
