Stablecoins are in the crosshairs of regulators nowadays. They emerged as a way to have assets on the blockchain that did not vary in value widely as other crypto coins do.
In this way, stablecoins would become much more widely used as a medium of exchange and store of value, rather than just trading, as many other cryptocurrencies are.
The stablecoin became a wild success and today they are traded at levels only seen in Bitcoin and Ethereum.
But what is a stablecoin?
How does it Work?
And what are the different types?
We’ll answer these questions for you in this article.
A stablecoin is an asset in the blockchain designed to retain the same value over long periods of time.
The value of a stable coin is mainly in relation to the Fiat currency of a nation.
The most used Fiat currency is the United States dollar, as right now, this is the currency used in over 90% of global trade.
So, most stablecoin out there mirror the value of the US dollar to a 1 to 1 ratio.
Of course, this is not the only Fiat currency used. There are stablecoins for Euros, Yen, Renminbi, Sterling Pound, etc.
The first classification for a stablecoin is based on what Fiat currency they track and that is what it is used to name them.
There will be a group of stablecoins for the dollar, others for the Euro, and so on.
But that classification is not very useful, as it does not describe how a stablecoin works. The most meaningful separation of stablecoins is based on how they work and we’ll look at it now.
Based on how they work there are two types of stablecoin:
Fiat backed and decentralized. Each has a very different core philosophy and yet both achieve the same end of keeping price/value stable.
It is important to understand the differences between them as future regulation might impact one of the two types.
So, let us begin.
A fiat backed stablecoin works by having money reserves equal to the amount of token in circulation.
This means that for every stablecoin on the market a centralized account keeps in reserve 1 token of the money it is denominated on.
On more simple terms. For a US dollar backed stable coin the company issuing the stable is keeping 1 dollar in a deposit for every 1 stablecoin in circulation.
Because they depend on a central authority for the issuance, Fiat backed stablecoins are sometimes called Centralized Stablecoins.
They all have a central authority that oversees the Fiat deposits and issues stablecoins based on them.
These deposits are held in financial institutions such as banks or trust funds which have to be audited periodically to show that indeed there are enough deposits to back each token in circulation.
Some famous examples of stablecoins are:
Tether is the biggest stablecoin in the market. It has 20 billion USDTs issued on different blockchains.
But Tether not only has USDT for the US dollar but also USDE for the Euro, USDY for the Chinese Renminbi, and also a gold backed stablecoin in the world for future deployment.
It is issued by Tether Limited, a Hong-kong based company in charge of managing the tether treasury.
In its accounts, one can find enough US dollars, Euros, etc. to back every token in circulation. At least, in theory, as many doubt Tether holds enough dollars for every USDT out there.
The second biggest stablecoin on the market there is almost a billion dollars in USDC out there.
It was created by the crypto exchange Coinbase as an answer to Tether. It is considered to be the safest stablecoin, as Coinbase releases monthly audits of the dollar reserves baking USDC.
For this reason, it keeps growing in popularity, as it’s very transparent.
Another popular stablecoin on Ethereum Paxos has over 250 million stablecoins in circulation. It is registered with the New York Banking Association, making it the only stablecoin under a regulatory body.
Paxos is a very safe stablecoin, though it is also very difficult to issue more, as each time it has to go through the bureaucracy of New York’s regulations.
Moving to our next category, Decentralized Stablecoins are those not controlled by one single party, as the case before.
In fact, they do not depend on a treasury holding Fiat money to maintain their value.
They do it by holding a group of crypto assets that in combination are worth a certain amount of Fiat money without having to have reserves of that money.
They are a very promising new technology and are at the forefront of innovation. Some examples are:
DAI is the most successful decentralized stablecoin created by Maker.
The inner working of the DAI token would be too complicated to explain in a single article but in short.
DAI maintains a 1 to 1 relation with the US dollar by holding 4 different crypto tokens which serve as the reserves to maintain the peg.
These tokens are Ether (ETH) the crypto coin of Ethereum, Basic Attention Token (BAT) from Brave Browser, USDC, and WBTC a form of Bitcoin which exists in the Ethereum blockchain.
Deposits in these 4 assets ensure that each DAI out there maintains a 1 to 1 ratio with the US dollar.
Anchor USD is the answer to DAI but for the EOS blockchain. The principle is the same, deposits on other crypto assets make sure each AUSD remains in a 1 to 1 ratio to the US dollar.
Though, in this case, EOS coins are used to keep the value.
It has become a great success in exchanges built on top of the EOS blockchain. It is also the second most successful decentralized stablecoin behind DAI.
As said before, the financial regulators are looking closely at stablecoins.
Right now in the United States, the STABLE Act is looking to regulate the market.
It would force stablecoin issuers to apply for a baking license before entering the market, and force them to go through official audits of their dollar reserves in order to keep operating.
If passed, this law would greatly affect Fiat backed stablecoins and make them more expensive to issue and maintain.
As of now, an enormous staff would need to be maintained by these companies to keep up with the demands of US regulators.
It would severely impact the viability of stablecoins such as USDT, USDC, TUSD, etc., and reduce their supply in the world’s market. Of course, since decentralized stablecoin doesn’t use Fiat reserves, it would virtually have no impact on them.
Perhaps making them easier to issue and shift the market from Fiat backed to decentralized stablecoins.
The stablecoin is here to stay regardless of the future of regulation.
It has become an integral part of the crypto economy and what of the great successes of blockchain. It will only grow as time moves on and become even more important.
Yet, we must keep a close eye on what are the latest developments and wait to see which type of stablecoin will become dominant in the market.
Stablecoins are integral to trading especially in swing trading, read Swing Trading Crypto: Essential Guide with Strategies to learn how this works.
