What is stablecoin and how does it work?

What is stablecoin?

Stablecoin is an important innovation designed to reduce price fluctuations in cryptocurrencies price, which can be used in exchanges and as a store of value.

Stablecoins are dependent on a "fixed asset" and these assets may be gold or physical currency (Fiat currency) or other types of backing.

Stablecoins, as their name implies, their price is constant in all circumstances and, like other cryptocurrencies, they do not fluctuate in the market.

In fact, the value of stablecoins is fixed only in relation to a particular currency or asset, while the currency or asset backed by stable coins can be of variable value relative to other units of measurement.

The most popular stablecoin, Tether (USDT), which is the fourth most valuable currency in the world today. This cryptocurrency uses the Fiat (US dollar) currency to support its price stability. It is often assumed that all stablecoins are produced with the backing of Fiat currencies; But there is also StableCoin backed by Gold, a cryptocurrency whose price equals the global price of gold.

Different types of stablecoins

There are different types of stablecoins In the crypto market that we are going to review some of them.

Stablecoins with physical currency backing

‌ The most common type of stable coins have the support of physical currency or Fiat money. Today, Fiat currency has the highest government support and the most financial transactions. As a result, this support for StableCoin builds the trust of users. The physical currency is the national currency of the countries, the paper money in your wallet and bank account. Such as Euros, Dollars, Pounds, Yen and…. .

Stablecoins are backed 1:1 by fiat currency: It means that one dollar Stablecoin is equivalent to 1 dollar of physical currency. This group is the simplest and most concentrated type of stablecoin.

Advantages

• They have a simple, understandable structure.
•   They are stable and supported by the government and the economy of a country, so there is a guarantee that prices will not fluctuate much.
•   They are the safest cryptocurrency for ordinary users.

Disadvantages

• Being focused makes them vulnerable. Factors such as bankruptcy of the central institution, economic recession can affect them.
• An external aud it is required to verify the accounts.

How to issue

Making transactions using this type of stablecoin is simple and quite similar to physical money. Therefore, it is necessary for people to buy StableCoin in a 1: 1 ratio fromits exporting company (most of the financial institutions of the countries) and use it in the relevant platforms. As a result, we have to trust these companies and be aware of their financial resources.

StableCoin with product backing

This group is backed by commodities that can be converted into money and used to trade in the same market. The most common commodity in this category is gold. Other precious metals can also be in this group. For a gold-backed stablecoin, a coin represents a certain amount of metal (for example, 1 token equals 1 gram of gold). This group is not as popular as the previous one, but it is a good choice for those who are looking for tokens with tangible support.

Advantages

• Their support is real and tangible.
• The price of backing goods is almost stable.
•   They are liquidable.

Disadvantages

• This group is also centralized and a third party is needed to ensure their performance.
• They need to be audited, and this is time consuming and costly.

How to issue

Doing transactions in this group is a bit complicated. The user must first log in to trading platforms and exchange gold for physical money. This gold is collected by the intermediary company and in return Stable Coin is provided to the user. Then smart tokens are entered into the trading network through financial intermediaries and can be traded with them. A digital card is issued to minimize the error rate.

Stablecoin backed by cryptocurrency

This group is supported by digital currencies. Of course, currencies with huge market capitalization such as Bitcoin (BTC) or Ethereum (ETH). Basically, a combination of several currencies is used as a backup, which makes it more secure because the risk of currency fluctuations is higher than a combination of cryptocurrencies, and also due to severe price fluctuations, a backup can not be a good store.

Advantages

• Decentralization
• Efficiency and liquidity
• Each transaction is recorded in a public blockchain, so it has full transparency and traceability.
• No external audit is required to control the transactions.

Disadvantages

• Since stablecoins are backed by cryptocurrencies, they are much more volatile than other assets, such as commodities or physical money.
• If the currency value of the currencies falls below a certain threshold, this support will automatically dissolve.

How to issue

This group has a simple transaction system. The person first saves the desired cryptocurrencies and then receives a stablecoin on the relevant platform. There is no intermediary between them and after saving the coins, they are automatically transferred to the user's wallet.

StableCoin without backing or algorithm

As their name suggests, this group has no support and acts like the central bank system. The riddle is that as demand for a StableCoin increases, new supply will be created to keep the price level stable.

Advantages

• Corrections and information are recorded on the performing chain so it is decentralized and transparent.
• There is no need for collateral to build new StableCoins because they are built or destroyed by an algorithm.
• Since stablecoins are based on market supply and demand, they are stable.

Disadvantages

• The complexity of this system is one of its disadvantages.

How to issue

Working in this group is also convenient. After request, people can receive their coin immediately and can then trade on the network.

What stablecoins are used for?

Stable coins are still in the early stages of development, but they can also be used in a variety of ways.

Contributing to the activities of cryptocurrency exchanges

Today, digital currency exchanges do not support Fiat currencies much due to the strict rules. This group of coins has helped to solve this problem and has made it possible for users to use crypto-fiat currency pairs, and as a result, the work of traders and investors has become much easier.

Using in everyday affairs

One of the advantages of stablecoins is that they can be used instead of fiat currency or common currency in daily sales. Not only do stablecoins have the advantages of cryptocurrencies, cryptocurrency fans dream of paying for their restaurant in these ways one day. 

Capital protector against falling Fiat values

If a country's national currency (Fiat currency) depreciates, the value of that asset is preserved by converting it to a cryptocurrency. As a result, given the sharp fluctuations in the price of cryptocurrencies, the best option to maintain stability is to buy stable coins.

International remittances and financial transfers

Stablecoins can be used to pay remittances and overseas finances, greatly reducing unnecessary conversions and commissions. Many international startups and trading companies can benefit from this feature, and even millions of migrant workers who are working outside of their own country can transfer money to their families this way.

Ease of peer-to-peer payments and smart contracts

In the future, using smart contracts, today's traditional services such as banking, insurance, lending, renting and payroll can be performed automatically and without intermediaries. In the meantime, stablecoins are the best option for this.

investment

In addition to all the above, stablecoins can be used in investment matters.

Stablecoins Limitations

For all the benefits we have listed for stablecoins, there are some limitations to using them that we will explain.

Establishment of Stablecoin Financial Institution

It is one of the most important limitations. Even the best and most stablecoins must be valued sufficiently by their intermediary financial institution.

Terms and Conditions

The obvious limitations of stablecoins are the rules and regulations. Countries make rules for their physical currency. These rules affect the stablecoin that supports the currency. 

Stablecoins can be legally controversial based on how they are used and the people who use stablecoins. Bankers and lawmakers suggest using this group of currencies, but some of them have problems competing with fiat money, which worries financial managers and banks. A good example of this is the Facebook stable coin project (formerly Libra and now Dim), which has faced many obstacles, even with billions of users.

Low liquidity

   Another limitation of stable coins is the low level of liquidity. In some cases, even if a liquidity problem occurs, the user of StableCoin has to go to the issuer country to follow it up, and it will incur a lot of costs and time.

Price volatility and the possibility of falling prices

   Although these currencies are stable, they are cryptocurrencies and their value may change. Changes in the price of stable coins are usually very minor and occur due to changes in supply and demand in the market.

Centralism

Fiat currencies-backed stablecoins and assets are far from the expected values in decentralized technology. This group is controlled and supplied by a specific institution that has a centralized nature and all the value of stable coins depends on our trust in these institutions. The audit and trust process is also performed by a third party company, which in turn contradicts the nature of decentralization and elimination of intermediaries.

Unforeseen events

Stablecoins are designed for normal market conditions and may fall sharply in the event of an unexpected event. This problem arose for the stablecoin (FEI). This coin, which was supposed to keep its price close to one dollar fixed without dollars (like Tether) and cryptocurrency (like Dai)support and only through the currency pool of FEI / Eth, initially dropped to half a dollar!

The most popular stablecoins of the market

Stable coins are very diverse and their number and degree of popularity are changing day by day. Here are some examples of the most famous ones.

• Tether (USDT) backed by US Dollars
• USC (USDC) backed by the US dollar
• Facebook's Libra cryptocurrency backed by Fiat currencies
• US Dollar (TUSD) backed by the US dollar
• UST
• Gold-backed Dai
• US Dollar-backed Packs (USDP) issued by the New York State Financial Services Authority
• MakerDAO with Ethereum cryptocurrency Support
• BUSD

Conclusion

In the above article, we tried to introduce you to the concept of stablecoin, to examine the disadvantages and advantages and their types to some extent. Stablecoins are growing and changing rapidly, and with the development of the cryptocurrency world, their types and functions will take another form and will become a fierce competitor of Fiat currencies.