Crypto assets have revolutionized the financial landscape, sparking innovation and attracting investors with the potential for significant returns. Yet, their unpredictable pricing has made them less suitable for everyday use. Stablecoins, on the other hand, are emerging as a steadier alternative, bringing consistency and unlocking practical, real-world applications. Reflecting this growing relevance, the U.S. has taken a significant step toward regulating stablecoins through the Senate’s approval of the GENIUS Act, paving the way for broader adoption and stronger trust in the digital economy.
What is a Stablecoin?
Stablecoins form a distinct category of digital assets designed to maintain price stability, offering a measure of certainty in an otherwise volatile crypto landscape. They function both as a convenient medium for day-to-day transactions and as a reliable way to safeguard value.
Unlike most crypto assets that swing with the market, stablecoins are tied to benchmarks such as the U.S. dollar. This peg helps ensure that sending $100 results in the recipient receiving an equal amount in value, making transfers simpler and more predictable.
Types of Stablecoins
Fiat-Backed Stablecoins
- These stablecoins maintain reserves of a fiat currency like the US Dollar or assets like gold and silver. They are used as collateral to guarantee that each token holds a 1:1 price with the underlying asset. Some examples of this type include Binance USD (BUSD) and USD Coin (USDC).
Crypto-Backed Stablecoins
- These tokens are collateralized using other large crypto tokens. Typically, these tokens are overcollateralized to ensure that volatile crypto prices do not affect the token’s price. Examples include DAI, which is collateralized by Ethereum and other tokens up to 150% of the value of the tokens. This insures the stablecoin against a decline in the collateral.
Algorithmic Stablecoins
- Algorithmic stablecoins may not hold any assets in reserve. Instead, the value of the token is maintained by controlling the supply according to a set formula. If tokens are minted and burned according to the demand, then their price can be kept at a steady level. This removed its peg from the US Dollar and made the token unreliable.
How Do Stablecoins Work?
Maintaining Price Stability
The most essential task for stablecoins is to keep their price pegged at the required level. Any major deviation from this level makes the token seem unreliable for transactions or other financial use cases.
How they do this changes from project to project. Fiat-backed stablecoins maintain reserves of the asset they are backed by.
Read more: USDT VS USDC
Crypto-backed stablecoins are different, in that you must deposit crypto tokens as collateral into the platform’s smart contracts. The smart contract then grants you stablecoins in return. Finally, algorithmic stablecoins do not have any reserves, so they manage supply and demand to maintain steady prices.
Reserve Management
Issuers of stablecoins must prove to users that the reserves are sufficient to exchange tokens for USD or collateral. Reserves are thus held in publicly viewable smart contracts or with trusted third parties like financial institutions. The reserves are also audited by independent sources.
Advantages of Using Stablecoins
Reduced Volatility
The primary benefit of stablecoins is that they eliminate or greatly reduce the volatility of crypto tokens. While this removes them from consideration as investments, it is a huge boon to their use in payments or financial applications.
Improved Liquidity
Another advantage is that since stablecoins are not held as investments, they flow more freely in the market. Additionally, minting new tokens is a quick and easy process that sends them straight to your crypto wallet. Many can also be converted back into fiat currency or crypto collateral easily.
Use Cases for Stablecoins
Payments and Transactions
Stablecoins finally make it easier for crypto tokens to be used in payments. Since the price does not fluctuate, businesses do not need to worry about their reserves falling in value. Higher usability and acceptance make stablecoins a compelling alternative to traditional modes of payment.
Trading and Hedging
Trying to use fiat currencies when trading crypto is an expensive and slow process. There is a huge fee associated with turning fiat into crypto and back again. Stablecoins greatly reduce the fees required, making the process much more streamlined.
Decentralized Finance (DeFi)
Stablecoins are essential to the DeFi ecosystem. One of the most popular DeFi services is lending and borrowing, which are usually conducted using stablecoins. They can also be used as a means of payment on the platform, to ensure its earnings remain stable.
Risks and Challenges
Regulatory Concerns
Stablecoins are currently not regulated by any central authorities. Thus, you cannot fall back on government support if a stablecoin project fails, like TerraUSD or Luna. Additionally, one platform’s reports may be very different from another, as there is no standardized reporting mandated by an authority.
Counterparty Risk
This is the risk that the stablecoin platform does not have sufficient reserves to return your collateral or convert tokens into USD. This can lead to an immediate collapse in prices and eliminate the main advantage of stablecoins. This risk is usually managed through the audits a platform undergoes to ensure that reserves match the coins in circulation.
Liquidity Risk
Liquidity risk can arise when platforms cannot issue stablecoins fast enough to match the demand. This can be a hurdle in many transactions where you may need new coins and can cause delays in several processes. However, this risk is usually short-lived, as when the project catches up to demand all stablecoins are minted.
Conclusion
Potential Impact of Stablecoins
Stablecoins have transformed the crypto space by enabling use cases that were once difficult to realize. They sit at the heart of the DeFi ecosystem, supporting trading, lending, and investment activities. Thanks to their stable value, these tokens also make everyday crypto usage more practical, creating a vital link between digital assets and real-world applications.
Future Developments and Advancements in Stablecoin Technology
The digital asset space is evolving quickly, and stablecoins have emerged as a core pillar of this growth. Backed by stronger reserves and improved stability frameworks, they are increasingly seen as a reliable choice for everyday payments. As infrastructure develops further, the creation of new tokens will become simpler and more seamless, paving the way for a financial ecosystem that is faster, more efficient, and trusted worldwide.
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FAQs on Stablecoins
What is meant by a Stablecoin?
A stablecoin is a form of crypto asset designed to minimize price fluctuations, making it more practical for payments and financial use cases. Most are pegged to fiat currencies or commodities, while some rely on algorithmic mechanisms to maintain stability.
Which Stablecoin is the best?
While it’s hard to single out one “best” stablecoin, some of the most widely used options are Tether (USDT), USD Coin (USDC), and DAI.
Disclaimer:
Crypto products and NFTs are unregulated and can be highly risky. There may be no regulatory recourse for any loss from such transactions. Each investor must do his/her own research or seek independent advice if necessary before initiating any transactions in crypto products and NFTs. The views, thoughts, and opinions expressed in the article belong solely to the author, and not to ZebPay or the author’s employer or other groups or individuals. ZebPay shall not be held liable for any acts or omissions, or losses incurred by the investors. ZebPay has not received any compensation in cash or kind for the above article and the article is provided “as is”, with no guarantee of completeness, accuracy, timeliness or of the results obtained from the use of this information.
