What Are Stablecoins? How Stablecoins Works?


One question that arises in everyone mind is how to save money when the price is falling? The answer is easy and almost everyone heard about it “Stablecoins”. In this post, we will put light on what are stablecoins and how stablecoins works? Without any further delay lets start 🙂

1 What are Stablecoins?

Stablecoins are a type of cryptocurrency those value will be backed by another asset value.

The pegged asset will be fiat currency, other cryptocurrency or precious metal (Gold, Silver). The easiest option among the three is fiat currency, means one unit of stablecoin is equal to $1.

Stablecoins are developed to tackle the volatility of the cryptocurrency market. Stablecoin is a centralised cryptocurrency and the price always equals to $1 (in case the coin is backed by USD). Stablecoins are normally collateralized means the number of circulating coins is equal to the asset reserved.

For example: If there is a total of 100,000 coins are in circulation then the stablecoin issuer company must hold $100,000 in bank reserve.

There are a lot of stablecoins now in the cryptocurrency market. Only a few of them able to make their name famous. Some best-known stablecoins are tether (USDT), trueUSD (TUSD), Gemini dollar (GUSD), and USD coin by Circle and Coinbase (USDC).

2 How Stablecoins Works?

The core function of stablecoins is to maintain a fixed price over time. There are different methods of achieving that.

As discussed above stablecoins are backed by either fiat currencies or metals or other cryptocurrencies.

The best and easiest way to deliver a constant price is to back the stablecoin by fiat currencies. For each and every single stablecoin issued by the firm, $1 for each coin must be reserved by a central custodian like a bank. If the fiat reserve is less than the cryptocurrency circulation then the price of the stablecoin may fall heavily. The stablecoin issuer firm should maintain the circulation supply and reserve in fiat currency. There are many stablecoins in the market those unable to maintain the ratio to 1:1 and the projects failed.

The second way to back stablecoins is precious metals (gold, silver), but this is not a good way to back cryptocurrencies. Gold and Silver markets are not constant and the price may vary every day (a small change in price), this will make it difficult to maintain the price of the stablecoin. Another problem is that how much and at which calculation the metals are stored at the custodians.

Another way to back stablecoins is by another cryptocurrency. The cryptocurrency market is not stable and there is high volatility in the market always. The price of the stablecoin will be maintained by providing $2 worth of the cryptocurrency for each $1 stablecoin. But the method will fail at certain conditions.

Smart contracts can be used to maintain the price of the stablecoin. Smart contract monitors the demand and supply of the stablecoin and will buy the coins when the price is too low and will issue new coins when the price is too high, this will maintain the price of stablecoin.

Any method will be used but the main focus is to maintain the stability in the price.

3 Why Stablecoins Are Necessary?

Stablecoins are necessary to save users funds from the volatility of the Bitcoin market and inflation of the national fiat currencies. Many countries are unable to control their national currency inflation and the value of the national currency is continuous to going down. Venezuela, Zimbabwe, Argentina are the best examples where the inflations rates are very high and people start investing in Bitcoin and other cryptocurrencies.

Here stablecoins play an important to fight with the inflation problems. Stablecoins can be converted into other cryptocurrencies easily in no time. These transactions are fast and cheap as compared to fiat currency transactions because of no bank and settlement fees.

Tether (USDT) a well-known stablecoin has reached all-time high transactions and the according to CoinMarketCap data Tether surpass Bitcoin in daily trading volume. The daily trading volume is $20 Billion (at the time of publishing).

Cryptocurrency exchanges provide different stablecoin trading pairs. This will allow users to convert their funds into stablecoins in case of any market downside move. Binance the leading cryptocurrency exchange is planning to launch its own stablecoin after the success of Binance Coin (BNB).

4 Are Stablecoins Achieve Full Decenterlization?

The answer to this question is NO.

Mostly stablecoins are pegged by the U.S dollar and many experts believe that the value of the cryptocurrency is based on the U.S banking system. The supply and reserve in the banks are managed by a centralised body, that is opposite of Satoshi Nakamoto vision he launched a decade ago.

Equilibrium claims that they achieved the decentralization of its stablecoin (EOSDT) that is overcollateralized above 170 percent. That ensures that the price of EOSDT is always $1. The company said “the world’s first decentralized collateral-backed stablecoin built on the EOS blockchain”.

Currently on EOS is used as collateral but the company is developing across chain solution which allows using other cryptocurrencies as collateral.

5 Stablecoin Problems

Stablecoins are always a controversial topic in the Crypto space. Tether the well-known stablecoin is always in news from the past few months. Research shows that the coin is used to manipulate Bitcoin price.

There is always a question that is the reserve in the banks and the circulating supply is in the ratio of 1:1. Recently reports show that only 74% of Tether coins are backed by the US dollar. Bitfinex the affiliate official partner of Tether has used Tether funds to recover a loss of $850 Million.

6 Big Names are Looking to Launch Stablecoin

Everyone is talking about launching a stablecoin. Even JPMorgan Chase bank is planning to launch its own JPM stablecoin to speed up the settlement in international transactions. JPMorgan Chase’s CEO called Bitcoin a “Fraud” back in 2017.

Facebook is planning to launch its own stablecoin later this year. Facebook hiring professional blockchain developers from the past year. Binance the leading cryptocurrency exchange will launch its own stablecoin within next two months.

New stablecoins will come and it’s interesting to see which one of them will win the throne of the stablecoins 🙂