What are stablecoins?

What are stablecoins?

Stablecoins – cryptocurrencies with a fixed rate, or resistant to its significant fluctuations. This class of digital assets adds to the well-known advantages of cryptocurrencies also low volatility of the exchange rate (or its almost complete absence). It can be achieved by linking Stablecoins to various assets (including fiat currencies, gold, SDR, digital currencies or crypto-asset baskets), or by reproducing on a decentralized basis some of the monetary policy elements used by central banks (Seigniorage Shares concept).

What are Stablecoins for?

Stableсoins perfectly perform not only the function of a medium of exchange – due to the stability of the exchange rate, they can also effectively act as a unit of account and a means of saving. This can allow many people to get paid in cryptocurrency, without fear of a sharp decline in its rate. Stablecoins can be an alternative to fiat currencies for residents of economically unstable countries, where inflation is high and currency restrictions are significant. Also, “stable coins” can be effectively involved in the market of cryptocurrency loans and derivatives. In addition, for a long time, Stablecoins have been popular among traders who buy more volatile cryptocurrencies “on the bottoms” and then sell them more expensive during periods of market recovery.

What are stablecoins by type of collateral?

Depending on the underlying Stablecoins collateral, three main categories of “stable coins” can be distinguished:

  • backed by fiat currencies (examples: Tether, TrueUSD);
  • secured with digital currency or a basket of cryptocurrencies (BitUSD from Bitshares, created on the MakerDAO platform and secured with Ether Dai tokens);
  • unsecured (Seigniorage Shares).

How are the stablecoins provided with fiat?

Stablecoins of this type are debt instruments. Each such Stablecoin corresponds to a unit of fiat currency held by a third party (for example, a depository bank). For example, a user deposits in USD to a bank account and receives Stablecoins in a 1: 1 ratio. When he wants to return his dollars, the issuer liquidates the corresponding amount of his Stablecoins and returns the required amount in this fiat currency to him.

DigixDAO works according to a similar scheme, except that gold, and not a fiat currency, acts as collateral for it.

What is the peculiarity of Stablecoins provided with cryptocurrency?

A cryptocurrency or a basket of digital currencies is used to provide this type of stablecoins. Such coins, as a rule, are provided with crypto assets in a ratio exceeding 1: 1. Since cryptocurrencies are highly volatile, such high requirements for collateral minimize the risks of Stablecoins issuer insolvency during periods of market collapse.

How is unsecured stablecoins maintained?

Stablecoins may not be secured by fiat, cryptocurrency or any other assets.

Seigniorage Shares is a concept of cryptocurrencies tied to fiat, which do not require collateral in other assets. It involves the reproduction on a decentralized basis of techniques similar to those used by central banks.

For example, to maintain the price of a “stable coin”, the issuer algorithmically changes the supply volume of such Stablecoins.

So, if the price of the “USD substitute” is above the $ 1 mark, the smart contract will issue additional “stable coins”. He will sell them on the open market until the price drops to the target mark. On the other hand, the issuer redeems tokens in order to maintain the price of a “stable coin” during periods of its excessively low rate. If the opportunities to support the course are already exhausted, and the price of Stablecoins is still below $ 1, then the issuer issues the so-called “Seigniorage Shares”. The latter enable Stableсoins holders to receive income from seigniorage (issuer’s profit) in the future.

It is easy to guess that the stability of such a system directly depends on the demand for this kind of stablecoins. This scheme may collapse if users lose confidence in such coins (especially if their rate continues to fall, the options for buying out coins have been exhausted, and the demand for Seigniorage Shares is insignificant or absent).

Examples of such Stablecoins include Basis and Havven.

What are the advantages and disadvantages of Fiatable Stablecoins?

Benefits:

  • easy to understand;
  • one hundred percent stability (subject to full security);
  • low exposure to vulnerabilities and risks of hacker attacks on the network (since the deposit is not contained in the blockchain).

Disadvantages:

  • the need to trust a third party – a custodian holding fiat currency;
  • requires the participation of another third party – the auditor, who would check the compliance of the volume of collateral with the offer of tokens issued to the market;
  • costly and slow withdrawal in fiat;
  • you high degree of regulation.

What are the pros and cons of Stablecoins secured by cryptocurrency?

Pros:

  • there is no need to rely on a third party to ensure the storage of collateral;
    higher level of decentralization;
  • On-chain transactions make it possible to more quickly regulate the offer of “stable coins”;
  • higher liquidity than Stablecoins provided by fiat (just one on-chain transaction is enough to pay off “stable coins” with the corresponding amount in cryptocurrency);
  • a high level of transparency in the absence of the need for an external auditor (monitoring is available to everyone).

Minuses:

  • not so high degree of stability of the course in comparison with Stablecoins provided by fiat;
    the probability of automatic repayment to the cryptocurrency in the event of a sharp drop in the rate of “stable coins”;
  • Dependence on the viability of another cryptocurrency (or basket of digital assets);
  • A slightly more complex system compared to the Stablecoins provided by fiat.

What are the advantages and disadvantages of unsecured Stablecoins?

Benefits:

  • no need for collateral;
  • theoretically, a higher degree of decentralization and independence, since there is no link to any fiat currencies or
  • crypto assets (however, with the general cryptocurrency market falling, demand for Seigniorage Shares may decrease).

Disadvantages:

  • a more complex monetary mechanism;
  • the need for steady demand for this kind of Stablecoins;
  • a high degree of vulnerability to shocks in the cryptocurrency market (for example, in the event of a market collapse, it may be difficult to redeem such coins);
  • the complexity of the analysis and assessment of the viability of such monetary systems.
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