When you consider the number of intermediaries in the financial system, the lack of clarity on new regulations stemming from recent events, and the volatile state of cryptocurrency markets – which can fluctuate wildly depending on news headlines – it’s understandable why many businesses are turning to stablecoins for stability. If you are interested in Bitcoin trading, you can simply visit an online trading platform like btcrevolution.io.
Stablecoins are digital currency that maintains a stable value. They don’t rely on complex blockchain networks or speculative trading. That means they offer businesses more flexibility when managing their finances and generally make use of cryptocurrency easier. In this post, we explore what makes sustainable coins appealing and how they compare to other forms of digital currency like Bitcoin or Ethereum.
All cryptocurrencies have one thing in common: they exist online. In the case of the most popular cryptocurrency, Bitcoin, transfers are made using a public ledger that allows anyone to see the transactions. The emergence of new cryptocurrencies or digital tokens led to a surge in investment and overall interest in blockchain technology related to distributed systems. However, there were still many cases where cryptocurrency was used as payment.
While it may seem like cryptocurrency offers many advantages over fiat (physical) money by providing anonymity and instant transfer capabilities, many of these benefits aren’t inherent to the currency itself – they come from the underlying infrastructure supporting it.
These advantages include the following:
Transactions are irreversible, making them safer. In the case of cryptocurrency, transactions would be impossible to reverse, even if an exchange has gone bankrupt. If you send funds to an incorrect address, the transaction will be final and irreversible without any chance of a refund; transactions would be impossible to reverse, even if an exchange has gone bankrupt. Likewise, if you send funds to an incorrect address, the transaction will be final and irreversible without any chance of a refund.
Advantages of stablecoins over cryptocurrencies:
A stablecoin is a cryptocurrency that maintains a stable value through control over supply and demand. The coin can be converted back into fiat currency at any point by either changing the supply or inflating it, ensuring a stable exchange rate between the two currencies. It is similar to the American dollar’s relationship with the gold standard. Foreign exchange is traded in terms of how many units of a coin are needed to purchase one US dollar.
For instance, if you are trading a Canadian dollar into US dollars, you would be interested in the price per Canadian dollar (Can$/CAD). If the price were CAD 1.2/USD, this would communicate that people could exchange 1.2 Canadian dollars for each US dollar, and the rate would effectively be 20% higher than the current exchange rate of 0. 8 USD/CAD. To maintain a stable exchange rate, central banks monitor money flow and act accordingly to adjust supply or demand.
Stablecoins do the same thing by controlling supply and demand. In terms of supply, the system acts as a central bank would with fiat currency, preventing the number of coins on the market. It allows cryptocurrency users to have alternative money that maintains a price balance within a set range. As for demand, stablecoins are based on algorithms that will enable central banks to monitor and control for changes in market behavior by manipulating price points relative to real-time events in financial markets. This way, a shift in demand can be detected and addressed before it has time to affect prices across the market.
Variants of Stablecoins are as follows:
- Commodity Collateralized:
In these cases, the coins are backed by commodities like gold or silver. The network’s native token is deposited into a bank and is kept there until a user wishes to exchange their stablecoin (at which point it is converted into fiat and deposited again)
- Fiat Collateralized:
In this case, stablecoins are directly backed by collateral in the issuing country’s currency and have their value pegged to that asset. In other words, if the price of a US dollar falls too low, investors can redeem their stablecoins for US dollars. These services are typically regulated.
- Seigniorage Shares:
These coins are backed by non-negotiable shares that have ownership in the medium of exchange itself. In these cases, investors can earn interest from investing in the service. These typically still have a central system that tracks changes in supply/demand and adjusts prices accordingly, but no actual asset or commodity backs up the value. It means if a user wants to cash out their value, they would need to sell their shares on the market.
Like stablecoins backed by fiat currency, blockchain-based tokens can be used as collateral to stabilize their value through supply and demand mechanisms.
- Algorithm collateralized:
These coins are backed by algorithms that control changes in supply and demand. In essence, these algorithms act as a central bank that would monitor and adjust supply and demand for the particular currency.
- Cryptocurrency Collateralized:
These currencies are stably pegged to another cryptocurrency, acting like a derivative contract that allows investors to hedge their bets through these services. Though their value isn’t directly tied to fiat currency, they are still roughly stable in terms of relative value. That’s because they are connected to another inherently volatile asset. After all, it is tied to real-world assets like gold and oil.