Introduction to Stablecoins

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gingerbreadfork
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4 min read

Learn how to store value without leaving the cryptocurrency market and leverage the power of stablecoins.

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Stablecoins are something that has shaken up the cryptocurrency world in recent years. These digital assets provide an alternative way to store value without altogether leaving the market and exchanging your crypto into your local currency.

What is a Stablecoin?

Stablecoins are digital currencies that intend to be more stable by pegging themselves in various ways to more stable fiat currencies or assets like gold and even oil in one case. As cryptocurrencies are known for being quite volatile, stablecoins form a haven when looking to store value with lower concerns of movement due to price volatility. However, while they remain relatively steady in value comparatively, it’s essential to acknowledge that the assets they are tied to shift in value on their own, albeit in a less aggressive manner to what you may be used to seeing as a bitcoin or altcoin trader.

Popular Stablecoins Include:

  • Tether (USDT)
  • Maker DAI (DAI)
  • USD Coin (USDC)
  • Binance USD (BUSD)
  • Gemini Dollar (GUSD)
  • True USD (TUSD)
  • Paxos Standard (PAX)

How to Stablecoins Hold Value?

The way each project works varies; however, many stablecoins rely on a relatively simple collateralization model of backing the value of each token/coin in circulation with traditional assets. Sometimes these assets are in the form of the pegged asset itself (such as USD). Other times this could be other traditional investments (similar to how a bank operates).

Other stablecoins take a more interesting approach, such as DAI from Maker, where network participants are incentivized to maintain a relative peg to the US Dollar. To use DAI as a stablecoin, you don’t need to understand how this works, and this is what a large number of DAI users do simply use the token. However, those that take things a step further can profit from helping maintain the peg using something called “collateralized debt positions” (CDP), where ethereum is used to provide collateral or even used as a way to get a DAI loan by locking up ETH in a CDP. If you’d like to learn more about how DAI maintains its peg, there are many great articles on how DAI works.

What Assets Make a Good Choice for a Stablecoin?

It’s unlikely we’ll ever see stablecoins for some currencies. In some regions, stablecoins form a growing way to escape the uncertainty of hyper-inflation and other forms of economic instability. Even gold hasn’t made a strong showing in the stablecoin space, as it in itself is a relatively speculative and somewhat volatile asset. Primarily large currencies that are considered relatively “safe” such as the US Dollar (USD), Euro (EUR), or British Pound (GBP) make it into the more popular pools. However, this seems to be growing in variety year on year.

While to some in the crypto world, talking about a fiat currency as a “stable” or “safe” asset may seem laughable, for now, the strength of these conventional currencies is where many traders find some degree of comfort and make for great tools for things like remittance where the waves of the bitcoin and other cryptocurrency markets can introduce additional risk. At their core, stablecoins form a bridge between crypto and traditional currencies.

Storing Stablecoins Securely

Most currently popular stablecoins operate as tokens on larger established networks like ethereum, or more recently, Binance Smart Chain or Tron. With this being the case, typically, you can store these tokens in a wallet that both support the network and the token you are trying to store. In the case of those ERC-20 tokens on Ethereum (such as DAI), MetaMask, MyEtherWallet, or MyCrypto can be great options or a hardware wallet from a reputable company like Trezor or Ledger.

Exotic Stablecoins

As we touched on earlier, not all stablecoins are backed by fiat currencies. Other alternatives exist, such as gold-backed stablecoins, including the Perth Mint Gold Token (PGMT). Another example, though one that comes with various ethical concerns, is the petro (₽), or petromoneda, launched in 2018 by the government of Venezuela. The petro was intended to be tied to oil production in the country. Still, after significant international concerns and already heavy sanctions, this project seems to be doomed to fail and essentially has already.

What are the Drawbacks of Stablecoins?

For collateral-backed stablecoins, there’s one concern that stands out from the rest. This concern lies in the fact that you are relying on a third party to provide and maintain the backing and trust in the stablecoin you are holding. When stablecoins first began to rear their head, this was a common concern and one that still lingers. However, with increased interest from regulators, the oversight on this is increasing. Still, whenever you are bringing a third party into your finances, it’s well worth considering how comfortable you are with doing so.

In short, stablecoins are a tool cryptocurrency traders across the world seem to be embracing to a growing extent. There’s a range of options to choose from, allowing you to find one that fits your needs. If you’re looking for something to reduce your exposure to the sometimes extreme volatility of many cryptocurrencies, stablecoins can be an excellent solution.

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