What are Stablecoins? The backbone of the crypto industry explained

8 days ago

What are Stablecoins? The backbone of the crypto industry explained

Stablecoins are a vital part of the cryptocurrency industry. They allow settlement between businesses at a large scale and also serve an important purpose for retail customers. But there is also a lot of regulatory pressure in this particular sector. Stablecoins have come so important that USDT became the third largest currency among all other cryptos according to its market cap.

There are a lot of misconceptions and myth evolving around stablecoins. With todays article we like to explain an asset that is not a typical cryptocurrency and yet has the potential to become perhaps the most important technology on the global market.

What is a stablecoin?

Cryptocurrencies are usually not issued by a single entity. Instead, they mostly rely on a decentralized model that follows a certain protocol. The protocol itself will determine the inflation rate and how much coins will ever come to existence. Stablecoins on the other hand rely on a centralized model. Meaning that a single entity is issuing these coins and guarantees that these coins are backed by actual fiat currency.

The most successful business model in that regard is Tether. The company’s most successful product is USDT, which is simply a token backed by the US-Dollar. But there are other solutions available and they are growing as well. Among them USDC and BUSD. While the former has also caught the attention of VISA, the later is used in the Binance ecosystem.

Stablecoins are powered by smart contracts. Meaning that they are simple tokens that can be issued or burned by the smart contract in question. To become more flexible the most common stablecoins are issued on different blockchains. These include among others Ethereum, Binance Coin, Tron, but also smaller projects like Algorand for example. In the end they rely on a centralized issuer who guarantees the value, but are powered by decentralized technology.

Why are stablecoins so important?

Cryptocurrencies are highly volatile. That makes them attractive for trading, but also more unsuitable for settlements. Traditional bank transfers are very slow. A transaction from China to South Africa might take days or weeks, but the cryptocurrency industry relies on international trade at a very fast pace. Not only retail traders like to move funds from one exchange to another.

Market makers, brokers and exchange themselves have the need to quickly settle transactions that are not subject to volatility. Knowing that stablecoins can be redeemed for US-Dollars, Euros or Rubel to finalize a settlement to the own bank account if needed. It’s amore sophisticated form of cash that can universally used for trade and regular transactions.

Are there any decentralized stablecoins?

Yes, there are quite a few. Most of them work through a DAO. Meaning that a protocol will allow to lend or borrow a certain cryptocurrency and in return receiving a stablecoin loan. If you are the lender, then you’ll earn interest on the amount that you hand over for a loan. The protocol ensures that the stablecoin is backed by something. Since there is not financial institution behind it, the collateral brought by both sides guarantee the value. The borrower’s collateral is also a very strong incentive to pay back his loan and the interest that he owes to the lender. Only if he is sticking to the agreement, he will get his collateral back.

One example for such a model is DAI, which is the stablecoin of the Maker DAO. The DAO and the DAI token are powered by the Ethereum blockchain. But there are also other decentralized models that are less known to the public. Haven protocol is such an example. Instead of powering a smart contract that allows borrowers and lenders to shape a market for stablecoins, this particular cryptocurrency allows to burn its native token in return for a so-called X-asset.

Such an X-asset could represent the value of the US-Dollar or Gold. Basically, each user is issuing X-asset by himself and in his own wallet by burning the equivalent amount of XHV. Once the user likes to redeem a stablecoin he can reverse the process and burns the stablecoin and gets back the equivalent amount of the native token. Here the value of the stablecoin is defined by the liquidity of the native token itself.

What is the difference between a stablecoin and a wrapper?

Stablecoins represent the value of an asset on the blockchain as a token. A very similar concept that is part of the broader DeFi ecosystem are so-called wrappers. A wrapper works very similar to a stablecoin, but is not representing fiat currency or a real-world commodity like gold.

Instead, a wrapper represents the value of a cryptocurrency within a DeFi protocol on another blockchain. Let’s take wBTC for an example. Here the wrapper represents Bitcoin, but on the Ethereum blockchain. With wBTC users can benefit from holding Bitcoin and its volatility, while at the same time interacting with DeFi products for lending, borrowing, liquidity mining and so on.

As well as with stablecoins there are decentralized wrappers that are not relying on a single entity as the issuer of the wrapper. But there also centralized version where users send their BTC to a single entity and receive the wrapper in return.

Will stablecoins replace cash?

This is not farfetched. In fact, projects like Facebooks Libra, which has only recently rebranded into Diem show that there is a market and that participants outside the crypto industry are interested as well. Governments also discuss the possibility of digital versions of fiat currency. The so-called CBDCs are not exactly the same as stablecoins, but they are offering very similar advantages.

If cash and bank transfers become a thing of the past remains to be seen. Not all governments are open to the idea of stablecoins and CBDCs. Most western countries are still experimenting and move rather slowly, while China already adopted their own CBDC issued by the government. Itis expected that Europe will develop a digital version of the Euro within the next two years.

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