Stablecoins offer a unique entry into the cryptocurrency world, blending stability with digital innovation. These assets maintain consistent value by tying themselves to reserves like dollars or gold. Investors flock to them to escape the wild price swings of tokens like Bitcoin. From trading to global payments, stablecoins serve practical purposes in today’s markets. Let’s explore their mechanics, types, risks, and potential for your portfolio.
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What Are Stablecoins?
Think of stablecoins as a type of regular cryptocurrency with unique features. However, instead of holding different price ranges as the market fluctuates, they are designed to hold a stable value by being pegged to an underlying asset.
These can include assets like the US dollar, gold and even other cryptocurrencies.
Unlike cryptocurrencies like Bitcoin (BTC) or Ethereum (ETH), which can be very volatile, stablecoin values are highly predictable, which makes them a popular choice for investors looking to avoid volatility while investing. Here are some further details about stablecoins, and how to use them in your investing journey.
How Stablecoins Work
So what does being “pegged” to an asset mean? This property of stablecoins means that they maintain a 1:1 ratio with their underlying asset.
For example, a stablecoin pegged to the US dollar will have a price of $1 per token, regardless of how harshly the market fluctuates. This applies to gold-backed stablecoins and various other types as well. Moreover, there are three major stablecoin types investors should understand. These include:
1. Fiat-Collateralized Stablecoins
This kind of stablecoin is backed by traditional currencies like the US dollar, or Euro held in reserves.
For every cryptocurrency issued, there is an equivalent amount of fiat stored in a bank. Good examples of these include Tether (USDT) and USD Coin (USDC), both of which are pegged to the US dollar.
2. Crypto-Collateralized Stablecoins
This kind of stablecoins are pegged to cryptocurrencies, instead of fiat. Considering how volatile cryptocurrencies can be in regular scenarios, these are often over-collateralized to keep them stable. For example, the DAI stablecoin requires more than one dollar’s worth of crypto to issue one $DAI token.
3. Algorithmic Stablecoin
These forms of stablecoins are not backed by tangible assets. Instead, they use smart contracts and algorithms to control their supply and demand. This means that they automatically adjust their own supply to maintain value. Examples include TerraUSD or UST (even though he collapse of the Terra ecosystem in 2022 raised concerns about how reliable they are).
Why Stablecoins Matter in Crypto Investing
Why should you care about stablecoins, and what can they do for you as an investor For starters, stablecoins are great as a hedge against volatility. Investors often use stablecoins to protect their portfolios from sudden market drops.
When the price of Bitcoin and other assets crash, holding stablecoins helps to preserve value. Another use for stablecoins is in Seamless Trading. Trading between cryptocurrencies can be complicated at times, especially when converting back to fiat. Consider the relative simplicity of a BTC/ETH trade, as opposed to a BTC/USDT or ETH/USDT trade.
Stablecoins also provide access to DeFi, with many platforms using them for services like lending and staking. Finally, stablecoins are great for cross-Border Payments, especially with how traditional financial systems can be slow or costly for international transactions.
Popular Stablecoins and Their Use Cases
Several stablecoins lead the crypto market, each with distinct use cases for investors.
Tether’s USDT for example, is the most widely used stablecoin. It is followed by Circle’s USD Coin (USDC), and both are mostly used for trading and remittances. Both have highly transparent reserves, which are audited regularly.
Binance’s BUSD (now FDUSD) is issued by Binance and is primarily used for trading and payments within the Binance ecosystem, along with the Binance Smart Chain. DAI on the other hand, is maintained by the MakerDAO protocol, with TrueUSD (TUSD) being an alternative stablecoin to USDT and USDC.
Some Issues With Stablecoins
While stablecoins offer unmatched stability, they also come with their own risks.
For example, governments and financial institutions are increasingly monitoring stablecoins because of concerns about money laundering and other issues. On the other hand, not all reserves are transparent. Tether, for example, has been subject to major criticism over the years for its unclear asset backing.
Another issue with stablecoins is the issue of Centralization vs. Decentralization. Some stablecoins are controlled by singular companies, and are, therefore, concerning when it comes to issues like censorship and control.
On the other hand, decentralized options rely on smart contracts that may have vulnerabilities. Tether’s USDT and Terra’s UST are good examples of this difference. Tether, the issuers of USDT have the power to freeze assets (which they have done in the past in instances of theft or terrorism).
While this factor is particularly useful in many circumstances, it does raise concerns about centralization. On the other hand, Terra’s UST crashed and wiped out billions in investor funds due to vulnerabilities with its smart contracts.
How to Invest in Stablecoins
Investing in stablecoins is relatively simple. It can also be highly rewarding if done right. To start with, choose a reliable exchange (like Binance, Coinbase or Kraken). This will allow you to buy and hold stablecoins securely until you are ready to convert to crypto or fiat. If you choose not to keep your stablecoins on the exchange, you will need a secure wallet to store them.
Consider purchasing a hardware wallet or choosing a secure software wallet for better security. A great way to make money off your stablecoin holdings without having to actively trade is with Yield Farming.
Some DeFi platforms offer interest on stablecoin deposits, and you should take advantage of them. No risky trades, no unexpected market reversals. Just passive income from your stablecoin holdings. Once you have all of this in place, make sure that the stablecoin you choose complies with regulatory guidelines in the country you live in to avoid possible legal issues.
The Future of Stablecoins
So far, stablecoins are becoming more and more ingrained in the crypto and investing spaces. Governments around the world are even looking into central bank digital currencies (also called CBDCs) as an alternative to company-backed stablecoins. Stablecoins may bridge traditional finance and crypto with proper regulation and transparency.
At the end of the day, stablecoins offer a reliable entry point for any investors into crypto investing. Regardless of your reason for investing in stablecoins, it is important to conduct proper research about an asset’s backing and regulatory status before investing.
