Nowadays, “stablecoins” are considered to be the safer version of cryptocurrency, as they enable users to enjoy the benefits of interacting in the ecosystem of the blockchain without having high volatility risks, as is the case with Bitcoin.
For the majority of its enthusiasts, cryptocurrency remains a speculative investment. This deviates far from what Satoshi Nakamoto envisioned about ten years ago when Bitcoin was created as an alternative and solution to today’s monetary system.
Early users adopted crypto to tap into the convenience of a decentralized currency that is transparent, cheap, secure, private, and instantaneous. However, cryptocurrency is still no match for traditional currencies because there is no certainty that the value of the cryptocurrencies that you hold today, will be the same when you wake up the next morning.
This led to the emergence of cryptocurrencies pegged to reserve assets, commonly known as stablecoins.
Simply put, stablecoins are a new type of cryptocurrency that offer low volatility risks and are backed by reserve assets that are expected to remain relatively constant over time, such as the U.S. dollar. Usually, a stablecoin and a reserve asset are pegged at a 1:1 ratio.
A popular example is the Tether (USDT), whereby one Tether exchanges for one U.S. dollar. Similar versions can be found with the Euro, Yuan, British Pound, among others. And while some of these world-leading currencies back most stablecoins, there are a few that are backed by other cryptocurrencies.
The MakerDAO’s DAI, for example, is pegged on a 1:1 ratio to the U.S. dollar on the exchange rate but is backed by Ethereum reserves. This means that regardless of how much the Ether coin fluctuates on its own, the value of DAI will not be affected, because it will remain at the same price as the dollar.
Beyond cushioning users against volatility, stablecoins also serve as an “in-between currency” between fiat and any cryptocurrency. Let’s see how this works.
Most cryptocurrency exchanges, such as BitcaribeX, offer crypto-to-crypto exchanges, fiat-to-crypto, and vice-versa services. It is here that stablecoins come into play by enabling crypto purchases for equivalent fiat. If, for example, an exchange is purely crypto-to-crypto, you can buy an ‘x’ amount of stablecoins for an equal value of U.S. dollars and use it to trade, buy or sell against another crypto on crypto-to-crypto exchanges.
Stablecoins are more than a “safe” digital asset. After a long day of trading, a crypto trader would be more comfortable keeping the day’s earnings at the same value that they finished trading. With regular cryptocurrency volatility, this is not assured. With stablecoins, however, traders are able to exchange their crypto for stablecoins and expect the same value the next morning. This enables crypto users to continue trading without having to cash out to fiat and back to crypto every day.
More importantly, given that people disassociate from bitcoin because it cannot be classified as a legitimate medium of exchange due to its volatility, stablecoins could help address the point of contention.
Already today, institutional investors, such as J.P. Morgan, are making inroads into the crypto space through stablecoins. Perhaps in the near future, such moves will contribute to taking bigger steps into greater adoption of cryptocurrency.