What are Stablecoins?

By Tectum expert Tectum

November 28, 2022

There is a question that newbies in cryptocurrency trading often ask, and it is usually “how do I know which is the best cryptocurrency to trade?”

Of course, the cryptocurrency market is very volatile and has been in a funk for most of the last year. Also, most of the time crypto traders are often told to check the crypto that best fits their profile and which is likely to appreciate the long term. However, a general rule of thumb to determine what crypto to trade is to determine what type of crypto it is.

There are three types of coins in the crypto market at the moment. They are 1. Bitcoin 2. Stablecoins and 3. Altcoins. In this article, we will discuss what are stablecoins? and why you should probably invest in them.

In trade, assets are often fixed against the value of one another. An asset such as a currency may be pegged against a reference asset such as stocks or precious metals such as gold or silver. The value of the asset is therefore fixed on the value of the asset that it is pegged against. If a currency (for example the dollar) is pegged against a precious metal (for example gold), the dollar will move up or down depending on the changes in the price of gold. Thus so far the price of gold remains stable the value of the dollar in this case will not change.

Because certain coins have become popular, they can be trusted enough to be backed up against other assets in the same way. Thus those kinds of coins like any other asset can also be backed up with reference assets such as fiat money, exchange-traded commodities, or even other cryptocurrencies. Once they are pegged their way, their value becomes stable concerning that asset hence the term “stablecoins”.

The principle is to ensure that the stablecoins are managed in good faith so that they can redeem the value of the asset they are pegged against. They are also not likely to drop below the physical value of that asset.

Differences between stable coins and Altcoins

Coins that are not stablecoins or Bitcoin are known as Altcoins. They are not pegged against anything, and they have nothing to cushion their value. Their value is only based on consumer interest and willingness to trade them. If for some reason consumers lose interest in using them, their value can go down to zero.

What are examples of the stablecoins that currently exist

There are several stablecoins that you can invest in. at the moment the top stablecoins are Tether (USDT), USD coin (USDC), Binance USD (BUSD), True USD (TUSD), Paxos Standard (PAX), Neutrino USD (NUSD) and Gemini Dollar.

What are the kinds of Stablecoins that exist?

Fiat money-pegged stablecoins

This category of stablecoins is pegged to a fiat currency (which is a regular currency such as the dollar Euro, or pound). At the moment the fiat currency that has the most coins pegged to it is still the dollar, however other currencies like the Turkish Lira will soon have their stablecoin pegged to them. It is believed that as long as the dollar remains stable the stablecoin backed with it should also remain stable.

Commodity-backed stablecoin

Some stablecoins are not backed by the dollar but are backed by commodities such as precious metals (e,g gold, silver diamonds) or industrial metals (like steel or iron). The thing about commodity-backed stablecoins is that their value is redeemable on demand. Also, the amount of the commodity that is used to back the stablecoin is reflected in the supply of the stablecoin.

Cryptocurrency-backed stablecoin

It is not uncommon to see a stablecoin backed by another cryptocurrency. A common cryptocurrency that often backs other cryptos is Ethereum. These kinds of coins are often regulated by smart contracts. Furthermore, the stability of the back coin is maintained by the introduction of supplementary instruments rather than just the backing asset.

Algorithmic stablecoins

These stablecoins are not backed by any fixed assets and they operate a different system altogether. The system is related to how Central banks handle currency. It works via the demand and supply principle. In this case, only the amount of stablecoins demanded is on the market. That way inflation or deflation does not occur. This type of stablecoin is often difficult in practice with far more failures than successes recorded for it.

Should You Invest in Stablecoins?

With this detailed explanation of stablecoins, does that mean stablecoins as an asset class is safe to invest in? or does it mean that it is safe than altcoins?

Generally, stablecoins are safe to invest in because the commodities they are pegged against are fairly stable. Also, the United States government has made moves to regulate the coins that are pegged against the dollar, so that they don’t undermine the dollar if they crash. That should give you as an investor a little more confidence.

unlike altcoins, the issue is that even though stablecoins are backed with stable assets, they are still cryptos, therefore they are still volatile. And their value can still drop tremendously. In that case, you still have to do your research and follow the statistics.

It is also worthy of note that because a coin is stable does not mean it cannot fail. For example, the cryptocurrency project Basis which was a stablecoin backed against the dollar failed in 2018 despite receiving over $100million in venture capital. Their reason was due to US regulations, Similarly, the Diem stablecoin was abandoned by Facebook/Meta,