Understand stablecoins in just 3 minutes

Understand stablecoins in just 3 minutes

The first stablecoin (Tether or USDT) appeared just under a decade ago. It is currently still the market leader, even representing the third largest cryptocurrency by market capitalizationwith a value exceeding $80 billion as of May 2022.

A number of stablecoins have emerged from Tether, helping to explode their use by cryptocurrency investors. We can cite Coinbase’s USD Coin (USDC) or even the Binance USD (BUSD) offered by leading exchange Binance.

What does this concept of stablecoin cover?

A stablecoin is defined as “a stable currency” which will be attached to a physical asset by replicating the value of a fiduciary currency, generally the US dollar. It is therefore a token not subject to the law of supply and demand like other cryptocurrencies. This indexing allows in particular to be exempted from the risk of volatility specific to the cryptocurrency market.

If they are initially exchangeable on the Ethereum network, more and more infrastructure blockchains now allow them to be exchanged, such as the Binance Smart Chain, Solana or even Tron.

StablecoinsRanking of the main stablecoins by market capitalization (source Coinmaketcap)

How do these stablecoins work?

Stablecoins can use different mechanisms to ensure the stability of their value:

  • Stablecoins backed by a so-called “Fiat” currency. In this case, a reserve of US dollars is made to offer a guarantee. It is equally conceivable that this consideration be gold or another raw material.
  • The so-called “crypto-guaranteed” stablecoins. This is to offer a counterpart with another cryptocurrency. To mitigate the volatility risk and absorb the fluctuations of the chosen cryptocurrency, there will be an over-guarantee that will apply. In other words, the cryptocurrency held in reserves will exceed the value of issued stablecoins. As an example, ethereum was chosen to support MakerDAO’s Dai stablecoin.
  • Algorithmic stablecoins rely on maintaining the value of the stablecoin through computer programs that will self-manage the monetary supply. Smart contracts will issue tokens when the price rises too much and buy them back when it drops.

What are stablecoins used for?

This form of “digital currency” is perfect for transfers from one exchange to another and all current transactions thanks to its ease of use.

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It has become one of the most popular ways to store and trade value in the crypto-asset ecosystem. They also ensure seamless payments of blockchain-based assets, increase transaction speed and reduce costs.

What advantages and disadvantages to derive from stablecoins

If these “stable currencies” offer many advantages, it is however necessary to know the risks specific to their uses.

  • These stablecoins theoretically offer stability that helps protect against the inherent volatility of cryptocurrencies and help preserve capital.
  • They are many more easily traceable than traditional fiat currencies.
  • Whether capital gains must be declared in the event of the sale of cryptocurrencies against a fiat currency (in this case the euro), transactions between cryptocurrencies, including stablecoins, are exempt from taxationregardless of the amount.

On the side of the disadvantages, we find mainly:

  • The holding a dollar for each stablecoin issued remains very theoretical. The companies issuing these stablecoins often hold government debt. But also corporate bonds, or commodities as collateral.
  • the lack of decentralization This is also problematic because these cryptocurrencies are owned by private companies. There is therefore a counterparty risk if the company is in financial difficulty.
  • the future risk of strong regulation by states and central banks to strengthen consumer protection and ensure financial stability. A way also to fight against money laundering and illegal financial transactions.

Conclusion: what future for stablecoins?

Become essential in the crypto ecosystem, the strong point of stablecoins is undoubtedly their attachment to a tangible currency.

But the appeal and interest of these stablecoins could evolve. Indeed, central banks are massively engaging in the development of their own digital currencies pegged to their fiat currency. This is particularly the case with China’s e-yuan, for example.

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