Stablecoins are cryptocurrencies with built-in price stability mechanisms. While some stablecoins are backed by commodities such as gold, the majority of stablecoins are pegged to fiat-issued currencies such as the Dollar or Euro. Throughout 2017 and even until today, stablecoins have gathered a lot of attention for their long list of benefits. As such, we’ve created this handy guide in which we’ll explain how stablecoins work, why they matter, and which you should choose from the many different options.
How Do Stablecoins Work?
The basic concept of a stablecoin is pretty simple: it’s a cryptocurrency that’s somehow designed to maintain a stable price, regardless of market conditions. But how do stablecoins achieve this? We’ll divide the answer into two parts, with the first focusing on fiat-pegged stablecoins.
Fiat-pegged stablecoins are stablecoins which are built to match the value of a chosen cryptocurrency – most often, the US Dollar. Many fiat-pegged stablecoins ensure price stability by holding reserves of the chosen fiat currency, only issuing new tokens to users who deposit an equivalent amount of the fiat currency.
While not all stablecoins can be directly redeemed for fiat currency, it’s this premise (and the ability to issue new tokens at any time, as outlined above) that mostly contributes to their stability. You can see how this works by looking at what would happen if the price of a stablecoin were to rise or fall:
- If a stablecoin were to rise in price – If the market price of a stablecoin were to rise, traders would purchase that stablecoin from the issuing organization in exchange for fiat currency. Then, they would sell the coin onwards for a profit (since the stablecoin has risen in price beyond its peg). The new supply of coins created by traders would cause the price to drop back down to its peg, thanks to the principles of supply and demand.
- If a stablecoin were to fall in price – If the market price of a stablecoin were to fall, traders would purchase that stablecoin from the open market. Then, they would redeem the coin with the issuing organization, also generating a profit (since the stablecoin was purchased for less than its peg). The growing demand for coins would cause the price to climb back up to its peg, thanks to the principles of supply and demand.
That’s at least how most stablecoins are designed to work; in practice, the exact mechanisms may differ slightly.
There are a few alternative approaches to building stability into cryptocurrencies. Although they’re nowhere near as popular (or advanced), other stablecoins derive their stability from:
- Commodities – After fiat-pegged stablecoins, commodity-based stablecoins are some of the most popular alternatives. Just like fiat-pegged stablecoins use stores of some fiat currency to guarantee the price of the cryptocurrency, commodity-based stablecoins often use stores of commodities to guarantee the price of the cryptocurrency. As of February 2019, some commodity-based stablecoins are already available on the market – mostly with a focus on gold.
- Supply management – Another mechanism that stablecoins can use to create stability is supply management. As the economic principles of supply and demand state, the price of an asset is related to the demand for that asset, and inversely related to the supply of that asset. Since there’s no way to control the demand for an asset, a stablecoin’s price can be controlled by close management of its supply.
- Real estate – Although they’re not normally classified as stablecoins, real estate-backed cryptocurrencies could also be viewed as such. After all, the real estate market is significantly more stable than the cryptocurrency market!
Why Do Stablecoins Matter?
The growing popularity of cryptocurrencies is due to their whole host of benefits, from decentralization, to transparency, to security, to convenience, and more. However, as market movements have shown in recent years, the cryptocurrency market can be extremely volatile.
This volatility is a major barrier for the general adoption of cryptocurrencies. After all, why put your money into cryptocurrencies if it could halve before you get the chance to spend it?
Some view stablecoins as the solution to this: they offer many of the same benefits as cryptocurrencies (transparency, security, and convenience, among others) but without that same, pesky market volatility.
Naturally, not everyone agrees with this sentiment. For example, many pro-Bitcoiners are against the adoption of fiat-pegged cryptocurrencies, as they often need centralized mechanisms and still rely on the government currencies some are trying to get away from.
Top Stablecoins in 2019
As of February 2019, the top three most popular stablecoins on our Coinpaprika market research tool are Tether (USDT), USD Coin (USDC), and TrueUSD (TUSD) – which all happen to be pegged to the US Dollar. Let’s dive into each of them and see how they differ!
Tether is the world’s most popular stablecoin, with a market cap of over $2 billion. Despite being credited as the space’s first stablecoin, Tether, which is operated by the Tether Limited Company, have come under fire over uncertainty at just how “pegged” the coin is.
For example, in April 2017, the currency fell more than 6% to under 94 cents per piece. This could be a result of the coin lacking one of the most important features for fiat-pegged stablecoins, which is the ability to redeem coins for fiat currency at any time.
USD Coin (USD)
USDCoin is the second largest stablecoin by market cap, amounting to just under $250 million. As we write this article, the price of USDCoin is sitting over a cent above the price of the Dollar, suggesting some price movement in the coin.
USDCoin was created in response to the many Tether criticisms, and has a focus on transparency. Its framework is open-source and the coins are supposedly managed by regulated, licensed financial institutions.
TrueUSD is currently the world’s third most popular stablecoin. It has a market cap of just over $200 million, and, like USD Coin, prides itself on transparency and security. Together with USD Coin, TrueUSD also gives users the option to immediately redeem coins for fiat currency at any time.