Stablecoins: What are they?

Michal Hladký

Trade has been a staple of our society basically since ever. And just as people themselves have evolved throughout history, so have trading and markets. Humanity notably made the biggest progress during the 20th century thanks to the great technological advancements that characterized this period. At this time, traditional markets were formed into the shape of we know them today. However, just like in technology, nothing lasts forever - especially in the dynamic world of business. Things or principles, which in their time were considered revolutionary innovations, become out-of-date throughout time by encountering their limitations.

Differences between old and modern markets

Living in the digital age we can buy most of the goods ourselves basically at any time and anywhere, but this is not the case on current stock exchanges. In short, traders have to adapt to the fact that exchanges have designated working hours within their respective time zones and therefore face the fact that if the exchange is closed, no trades will take place. In addition, an ordinary human cannot even get his foot in the door of the classic stock market. Instead, they have to resort to using the services of various third parties and intermediaries processing the actual trades.

In contrast to this model are exchanges where digital assets are traded. A progressive environment was created around the first cryptocurrency and the revolutionary idea of decentralization, which breaks down long-established limits with its operation. Today it is completely unimaginable for any cryptocurrency trader to be forced to wait for the given exchange to open and allow him to carry out the operation in order to execute his trade.

It is important to remember when Satoshi Nakamoto presented his invention to the world, only thirteen years have passed since that moment. In such a short period of time, the entire cryptocurrency industry has evolved into its current shape and size.

Tokenization - what is it exactly?

The dynamic and potential of cryptocurrencies are attracting the public eye more than ever before. There is an increasing number of visions and attempts to merge the best of both worlds. One of the basic principles that are key to this connection is the gradual tokenization of all traded assets. Some see it as one of the biggest challenges of this decade.

What exactly tokenization is? The answer is simple. Every asset traded on the exchange receives its dedicated proxy token. These tokens and principles used in digital asset markets will then help bring traditional markets into digital form.

The emergence of stablecoins

Although the idea of creating tokens sounds simple at first glance, overall it is a complex process. For example, just look at the process that FIAT currencies had to go through before they could even be tokenized. Several years have passed since the introduction of the first cryptocurrencies of this type and even though they have established themselves on the

market, this area is still developing. And above all, there are still continuing discussions about its further direction.

Nowadays, there are already many tokens linked to a certain currency. The most well-known of them are based on the dollar, but there are also those that are linked to the euro, rupees or even Turkish lira. There also have been attempts to link various commodities to stablecoins.

Even as early as 1996 – long before the rise of cryptocurrencies and blockchain as we know them today – Gold & Silver Reserve Inc. introduced a digital currency called E-Gold, which was backed by an appropriate amount of gold. At its peak, the service had up to five million active users.

All pegged cryptocurrencies are characterized by very low volatility, thanks to their peg to a specific underlying asset. The stability that this group of cryptocurrencies is characterized by eventually led to the establishment of the general name of stablecoins. In the rest of the article, we will mainly talk about stablecoins tied to the American dollar.

Stablecoins and their benefits

Like any invention, stablecoins have the noble task of making life easier for their users. The main purpose was to enable trade against the dollar value without involving the actual dollar conversion in the transaction itself.

All you need to send and receive them is an ordinary crypto wallet. Stablecoins significantly simplify various transactions, even in areas where dollar payments cannot be made. In countries affected by high inflation, they can to a certain extent serve as a simple tool for securing the value of funds.

A trader can leverage his funds by trading any cryptocurrencies. However, it is known that the cryptocurrency market is a volatile environment in which there is no shortage of occasional thunderstorms. In the event of such a storm bringing large waves in the form of volatility, one can now withdraw from the turbulent market waters at any time to the safe harbor of stable currencies firmly tied to FIAT:

What stablecoins are out there

Centralized stablecoins

Tether, USD Coin and TerraUSD are among the big players in the current market. For example, the giant Binance came up with its very own stablecoin - Binance USD (BUSD). All of these currencies are centralized and based on the trust of traders in the issuer of the stablecoin, which here represents and supplements the function of the central authority. Simply put, traders believe that the stablecoin issuer backs all coins with the same amount of FIAT currency.

However, as it happens in the world, even this invention over time found its supporters as well as its haters. And so even with the topic of stablecoins, there are still ongoing discussions about how and if these tokens should work at all, or at least be regulated.

Tether – a controversial number one?

The largest traded cryptocurrency of this type – Tether (USDT) – has had several controversies behind it. At the time of writing, the total number of issued tokens according to the CoinMarketCap search engine was $84.5 billion. In practice, this would mean that the Tether issuer must keep the same figure in dollars or other assets of the given value on their accounts. According to figures from 2021, such a sum would shoot the company holding deposits up to 32nd place in the ranking of American banks according to the number of deposits held.

The risk, however, is that while banks are subject to clear rules and regulations, the issuer of USDT – Tether Limited – is not. Therefore, a company operates on the official market, which with its features and nature of business is to a large extent similar to a banking institution, but the established rules do not apply to it.

There is concern among the cryptocurrency community that the eventual collapse of the company could throw the entire cryptocurrency market into trouble and wipe it out completely.

The size to which the whole Tether has already inflated is not giving some skeptics a good night's sleep. There are fears that its possible difficulties could significantly destabilize the financial system as such, in addition to cryptocurrencies.

On top of that, Tether has been convicted of lying and making dubious transactions in the past, and therefore it is no wonder that there is some tension within the community. Even in this case, the question arises as to whether the introduction of a regulated environment would calm the whole situation down. This would give giants like Tether clear guidelines on how to behave and would surely reassure the general public.

We have written an article for you about regulations on European soil. Read more about the regulation known as MiCA.

USDC – a reliable number two?

It is exactly because of the unpredictability of Tether that the cryptocurrency community is trying to find a suitable alternative that will have all the advantages and perks of stablecoins and at the same time will appear more trustworthy than the current number one stablecoin.

There are many options being discussed, but the USD Coin (USDC) seems to be the most popular option at the moment. As we repeatedly mention in our texts, how it is accepted by the world of traditional finance is also important for the credibility and stability of the cryptocurrency. And in this regard, the USDC issuers - the Center consortium - managed to take a significant leap forward and get on their side an important ally, which is Visa. It already announced in 2021 that it will also conduct transactions in its network within the framework of the USDC cryptocurrency, which significantly increased its credibility.

What about decentralization?

Due to the fact that in the beginning cryptocurrencies were primarily supposed to be decentralized, stablecoins were created in this case as well, which work with the idea of decentralization. One of the most famous is the DAI cryptocurrency with tokens of the same name.

Very simply, it can be said that DAI tokens are created with the help of smart contracts created through the Maker DAO platform. In this case, the user places a pledge, the so-called collateral, into the system. Subsequently, DAI tokens will be generated, which are covered by the given pledge. In case the user decides to unlock the collateral again, he pays the appropriate amount and the processing fee using DAI tokens.

Unlike centralized cryptocurrencies, which require user trust, decentralized ones seem more secure. Smart contracts ensure that there are always exactly as many tokens in circulation as can cover the deposited collateral.

In conclusion

As per the lines above, even stablecoins, despite their name, are not as stable as they might seem at first glance. Mainly due to the fact that it is a fairly young area. And as with the entire cryptocurrency world, it will be interesting to see which way the industry continues to evolve.

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