Explaining Stablecoins; Are they Really the Next Big Thing?

Explaining Stablecoins; Are they Really the Next Big Thing?

09/08/2020 by Koinal
A stablecoin is a type of cryptocurrency whose value is backed by a physical asset. The reserve or asset can be a cash currency, gold, or a basket of valuable things. The purpose of asset-backing is to provide price stability in the cryptocurrency marketplace. It is a hedge against high volatility.
what is stablecoin

The benefit of asset backing is that the value is consistent through the life of the coin. The assets do not rise and fall in value due to crypto market factors. To the extent that there are fluctuations, they should be small. Asset-backed coins may change in value as the underlying asset changes. For example, the value of the dollar can rise and fall on global markets. The ratio of 1:1 will exist, but the value of a dollar may change due to economic conditions.

Volatility Is the Target

Asset-backed coins provide a reduced level of risk. In the regular cryptocurrency markets, the value of one or all currencies can rise and fall connected with a wide range of factors, events, or market conditions. In some cases, the sharp rises and falls have no apparent cause. The assets that back the coins do not change due to cryptocurrency conditions.

The idea of stablecoins is to peg their value to a specific asset or group of assets. Asset-backed coins can help achieve the below-listed goals.

  • Offer stable prices within a cryptocurrency market
  • Support Cryptocurrency payments in international transactions
  • Provide a market mechanism to move into or out of cryptocurrency positions without converting to government-issued currencies 

How Does Asset Backing Work?

Asset-backed coins are a digital currency type that uses smart contracts to peg their value to an external source. The value can be on-chain and incorporated into the token by a smart contract. The value can be off-chain and overseen by a central authority like a financial institution.

There is more than one type of stablecoins. They may have fiat currency backing, cryptocurrency backing, or commodity backing.

Fiat backed stablecoins usually have a 1:1 ratio of fiat currency and a cryptocurrency. For example, the token may have a one Euro or one US Dollar backing. Currency-backed coins must have a trusted third-party to attest to the fiat reserve. The number of coins must equal or be less than the amount of currency that backs it.

Fiat collateralized stablecoins work well in international settings.

Crypto backed stablecoins have a 1:1 backing of a specified currency such as ETH or BTC. The fiat backing must be on the blockchain as a smart contract.

Commodity-backed stablecoins have an asset or a basket of assets as backing. The number of coins in circulation must match the value of the assets held in reserve. This type of support can be tricky since some of the commodities can fluctuate. For example, when tokens use gold or silver, the product can fluctuate in value.

The algorithm used for backing uses a system called seigniorage to adjust the value of the assets. The algorithm in the smart contract continuously improves the asset backing. 

Where Can You Buy Asset-Backed Cryptocurrency?

Buyers can acquire stable coins at cryptocurrency exchanges. Most exchanges require the use of cryptocurrency or some specific type of bank authorized transfer or bank wire. Koinal offers a simple and effective method to purchase cryptocurrency on exchanges. Through the Koinal portal, buyers can buy cryptocurrency using a bank credit card or bank debit card.

Examples of asset-backed coins on the market today include Binance GBP Stablecoin, Tether( USDT), TrueUSD(TUSD), DAI Stablecoin, and USD Coin (USDC).

Is Stablecoins Safe?

The asset-backed coin creates a firm price range for the currency. There are issues that investors must consider. For example, precious metals may be hard to obtain at various times, and market conditions can affect the 1:1 ratio. Further, centralization is an issue since one must rely upon the trusted third party’s role to confirm the assets for off-chain coins.

The overall system that supports smart contracts is based on the Ethereum platform. Like all systems, it can experience higher than expected volumes and require maintenance, upgrades, and expansion.


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