While cryptocurrencies like Bitcoin and Ethereum dominate the headlines with bulletins about astronomical all-time highs or heavy losses, stablecoins tend to be less in the spotlight.
While popular stablecoins such as Tether, USD Coin, DAI, and Binance USD are all among the largest cryptocurrencies in the landscape by market capitalization, their role is largely underestimated.
Despite this, stablecoins play a huge role in cryptocurrency and are popular assets for both investors and traders. So what exactly are stablecoins and why are they different from other cryptocurrencies?
What is a stablecoin?
Stablecoins are a form of cryptocurrency altcoin that aims to provide price stability within the cryptocurrency market. While the values can be tied to a range of different assets, the ultimate goal is to maintain a constant value regardless of wider crypto market fluctuations.
Many popular stablecoins such as Tether and USD Coin are pegged to the value of the US dollar and will therefore try to hold a value of $1. This means USDT and USDC are always worth $1 no matter how volatile the market gets.
While many stablecoins are pegged to the value of the dollar, they can also be backed by other assets and precious metals such as gold. This works because stablecoin makers can hold a reserve of fiat currencies like the dollar or commodities like gold as collateral, guaranteeing the value of the stablecoin.
As the oldest stablecoin of its kind, Tether provides us with an extensive history of stablecoins in practice. Looking back at its performance in the years since its introduction in 2015, we can see that the value of USDT has remained largely unchanged, although history also shows that anomalies can occur.
Of course, USDT’s price history couldn’t look more different than that of Bitcoin, a cryptocurrency pre-programmed to become increasingly scarce over time due to the gradual halving of new BTC produced for miners. With a maximum circulation of 21 million Bitcoin and no real-world asset pegging, we have seen Bitcoin’s value rise and fall in a volatile fashion.
In addition to their varying levels of market performance, stablecoins are generally regulated in ways that decentralized cryptocurrencies are not. This again helps keep the stablecoin landscape free of the famous levels of volatility experienced by the wider market.
But what sets stablecoins apart from traditional cryptocurrencies for investors? And why are stablecoins so technically different from their counterparts?
How are stablecoins different from other cryptocurrencies?
The world’s most popular cryptocurrencies, such as Bitcoin and Ethereum, are known as free-floating crypto, meaning they behave similarly to commodities and derive their value from the supply and demand market for the asset itself.
Because their value is not tied to any other asset or algorithm, they can experience significant price volatility.
This means that investors would buy stocks like BTC and ETH expecting their investments to fluctuate significantly. However, stablecoins will always equal the value of a more traditional asset, presenting several opportunities for investors. These can be:
Unlike traditional cryptocurrencies, stablecoins do not have a limited supply or set schedule, meaning they are paid out based on market economies and conditions. These assets are backed by collateral to help investors protect against market downturns in more traditional cryptocurrencies.
For traders, this means that stablecoins can be an extremely useful asset, and it is not uncommon to see large trading volumes pouring into Tether when a near-term market decline is expected in assets such as Bitcoin. In addition, some exchanges, such as Bitfinex, require users to purchase Tether before converting their holdings into other assets.
Call for venture capital
Another major appeal for stablecoins is that they can experience large inflows of venture capital.
While this may seem counterintuitive for VCs, the fact that a lack of volatility means investors are unlikely to see a profit from buying stablecoins. The development of new business models linked to the stablecoin market offers venture capitalists and private investors better opportunities to make investments and build profitable portfolios.
There are also ways investors can earn rewards simply by holding stablecoins, and in many cases the assets can provide higher returns than traditional bans would provide.
For example, USD Coin offers up to 4% strike yield, while other less commonplace stablecoins like USDD can offer as much as 8% strike rate.
Boundless cheap transactions
Another key benefit to stablecoins is that their fast processing and low transaction fee infrastructure make it possible to send money anywhere in the world without the hassle of converting fiat currencies or paying high fees.
As for the low cost, it’s worth emphasizing that the cost of sending large amounts of money can come at a relatively miniscule cost. For example, Coinbase reports that some individuals have sent more than $1 million in USD Coin with a transaction fee of less than $1.
Stability and market risk management
In summary, stablecoins provide stability across the cryptocurrency landscape in ways that traditional crypto cannot match. Their low transaction costs and traditional asset collateralisation mean they are excellent tools for traders navigating volatile markets and for those who need some respite after a crypto drop.
However, it is also important to emphasize that the stablecoin ecosystem is not entirely risk-free. In the past, leading stablecoins like Tether have faced controversies based on asset stability.
While stablecoins may present themselves as risk-free assets, they are by no means immune to risk and could run into trouble during testing periods for the wider crypto ecosystem.
With this in mind, investors can take solace in stablecoins and reap their benefits in ways that traditional crypto cannot match. But as always, it is essential to remain vigilant in a crypto landscape that is known for being unpredictable. By staying prepared for the unexpected, investors can be best prepared for unexpected complications should they arise.