A “stablecoin” is a type of cryptocurrency whose value is tied to an outside asset, such as the U.S. dollar or gold.
The company that created the crypto will have a reserve that matches the number of units they have in circulation.
It’s like a collateral.
You should be able to exchange one unit of a stablecoin for one unit of the asset that backs it.
Tether, for example, is pegged against the US Dollar. This means that no matter what happens, 1 Tether is worth 1 dollar.
Fundamentally, this goes against the very principle of cryptocurrencies. Bitcoin, in particular, was created to bring the control of currencies back to the public instead of the government.
I won’t dwell on the debate though. This video is just to explain stablecoins and its purpose.
So, why was stablecoins created?
For stability. Bitcoin and altcoins’ values are pegged against itself which causes its volatility.
This makes them hard for everyday people to use. Generally, people want guarantees and predictability. They want to know that their dollar will still be worth the same in about a year.
Cryptos can crash in minutes.
On your screen right now is a graph created by Coindesk. It compares the value of USD to Bitcoin and you can see that the Dollar is pretty stable. At least in face value.
Aside from the US Dollar, there are some other assets that are used.
This includes precious metals and other cryptos.
Recently, Tether released their financial statement and revealed that they also have other assets such as real estate, ETFs, and others.
Some popular stablecoins are Diem, Tether, Dai, and USD Coin.
Diem, formerly known as Libra, is a stablecoin created by Facebook. It hasn’t been released but they did say that it will be backed by a “basket” of currencies, including the U.S. dollar and the euro. But there are some controversies that caused the delay of its launch.
Tether is probably the oldest stablecoin in the market now. They created it to allow moving of money between exchanges quickly. Since there are discrepancies between exchanges, traders can make money on the discrepancies by moving their assets quicker.
So, what’s the disadvantage of stablecoins?
Well, it’s only as stable as the asset it is pegged against. The US Dollar, for example, is also unstable. With the double digit inflation rate? Your $1 last December isn’t as valuable now.
There is also the issue of security. Where are the assets stored? What if those get lost or stolen.
And the most important question, how does the company prove they really have the assets equivalent to the number of units they have in circulation.
The most important one is the fact that it is pegged against something cryptocurrencies were created to fight, control by a centralized entity.
But as promised, that’s another video and you can watch it by finding the link below.
In the meantime, you can consider those things before investing on a crypto.