Digital currencies have made global payments easier and accessible. One of the notable options available is Stablecoins and it is making a lot of impact in the market.
Stablecoins are gaining popularity due to their spontaneous growth, advancing global use cases, and possible volatile financial vulnerability streams. They are cryptocurrencies designed to be more stable than other crypto assets. Some are backed by the asset reserve to which they are associated, while some use algorithms to prevent their price values from rapid fluctuation.
A stablecoin’s price depends on the price of the volatility of crypto assets caused by negative cryptocurrency news and human emotions when you buy Bitcoin with credit card. This is opposed to the usual mining on an open, decentralized network of computers completing a series of calculations and documentation. Its most basic function is being a common denominator for volatile cryptocurrencies.
How Do Stablecoins Operate?
Stablecoins are backed by a collection of assets that extend beyond crypto to certain fiat currencies and other influences. Examples of these fiat currencies and influences are the US dollar, rare metals, and algorithms. Hence, it can be safely implied that the source of a cryptocurrency’s backing can influence its relative risk.
Stablecoins backed by a fiat currency may demonstrate more stability due to ties to a federal financial system with centralized authorities. Stablecoins that are backed by other crypto assets may fluctuate rapidly over time. This is mostly due to the absence of a regulation board governing the crypto assets each stablecoin is pegged to.
Types of Stablecoin Backing
Fiat-backed stablecoins are IOUs because you purchase your stablecoins with your relative fiat currency, which can later be converted to your original foreign currencies. Unlike other cryptocurrencies, the price value of fiat-backed stablecoins can only have minimal fluctuation.
Other cryptocurrencies influence crypto-backed stablecoins. Since the underlying asset has high volatility potential, stablecoins backed by cryptos are overcollateralized to reduce the risk for the HODlers, enhance the stablecoin’s trading rating, and increase its stability.
Stablecoins backed by precious metals depend solely on gold and other rare metals to sustain their stable cryptocurrency market valuation. These stablecoins are similar to Fiat stablecoins with their centralized features, although, for certain reasons, some crypto users consider this a disadvantage. However, its main aim to protect the volatility of stablecoins is still appreciated.
Algorithmic stablecoins have no underlying asset. These stablecoins depend heavily on complex computer algorithms to maintain a stable value.
What Value Do They Hold On the Market?
The market valuation of all stablecoins is currently worth 151.66 billion dollars, representing 15.91% of the entire crypto market cap. This makes them a minor part of the cumulative crypto market. However, their popularity has surged due to more people investing in cryptocurrency.
They play a key role by creating a hedge against market volatility in Bitcoin (and other altcoins) while trading on exchange platforms. They also help when people store liquid assets in their crypto form. The fundamental roles of stablecoins are as follows:
- Stablecoins are globally decentralized cryptocurrencies that are created to offer price stability.
- They serve as a bridge between cryptocurrencies and real-world assets such as gold, fiat, etc.
- Because of their relatively low transaction fees, stablecoins are preferred as a cheap medium of exchange.
- Stablecoins provide much liquidity in Defi systems such as DEXs and lending ecosystems. This is because they can be invested and used to earn interest rates over fixed staking periods.
- Stablecoins reduce regular crypto volatility by holding collateral reserves, often in the US dollar form.
- Algorithmic stablecoins provide consistent value by modifying supply relatively with current market demand based on predefined algorithms.
Future of Stablecoins
While stablecoins already play some important roles in the crypto ecosystem, they still need many improvements and regulations. This is to make sure its current potential flaws are not exploited. For example, many stable coins are minted on proof-of-work (PoW) consensus ecosystems. This method is, however, relatively slower, less scalable, and engenders high power consumption compared to networks that use proof-of-stake (PoS) protocols.
PoS protocols increase transaction speeds by reducing validators and lowering the computational power required to verify every transaction. However, this may affect security, scalability, and decentralization. The high amount of withdrawals induced by faster transaction speeds are causing DEXs to limit withdrawal options for users. Yet, this should not be; users from around the world should be able to access their funds anytime.
Furthermore, customer data protection policies (such as confidentiality, cash back, surcharge, and cyber scam compensation) currently do not apply to stablecoins.
Financial Sustainability Risk Factors Emanating From Stablecoins
Stablecoins may present risks and vulnerabilities through different streams. Among these streams are:
- Counterparty risk
- Reserve risk
Stablecoins offer some stability which most digital currencies struggle with. However, the cost and speed of stablecoin-related transactions and their recovery T&Cs are below the practical medium of exchange’s requirement in many economies. Nevertheless, those who know how to buy cryptocurrency and own stablecoins should be aware of their risks. Even though stablecoins appear to have few risks, this can quickly become the opposite if proper regulations to enforce effective crypto asset management fail. Effective financial regulation for stablecoins is crucial for risk-free innovation and stability.