There are approximately 200 stablecoins available in the market today and there are highly volatile markets, cryptocurrency users and investors find it hard to utilize the markets with their reliance on valued transactions. The answer to this question is issuing stablecoins, but there are many intransparent and sometimes flawed ways of pegging the value.
What are stablecoins? Stablecoins are cryptocurrencies that are basically pegged to the value of an asset, be it a fiat currency, a commodity, or another cryptocurrency. What are the types of stablecoins? The different types differ in such a way that they can position themselves on either the fiat-collateralized, crypto-collateralized, or algorithmic pegging, each with its respective positive or negative aspects.
In this blog, we will look in detail What Are Stablecoins? Pros And Cons Of Pegging Methods In Cryptocurrency, What Are The Examples Of Stablecoins, and what are the problems with stablecoins?
What Are Stablecoins?
A stablecoin, sometimes referred to as a pegged cryptocurrency, is pegged to the value of at least one of the following: a fiat currency, a commodity, or any other tradable asset. This nature of pegging imposes a restraint such that the value of the pegging cryptocurrency has to be relatively stable and in line with the value of the underlying.
The design of the pegging mechanism is set in an extraordinary way, which can reduce the volatility and offer a medium of exchange that becomes more predictable and reliable.
Types Of Stablecoins Pegs in Cryptocurrency?
There are various types of stablecoins pegs in cryptocurrency and there are also pros and cons for each pegging method in cryptocurrency:
There are majorly 3 types of stablecoins and they are as follows:
- Fiat Backed Stablecoins
- Crypto Backed Stablecoins
- Algorithmic Backed Stablecoins
Now we will dive into looking at the pros and cons of each of these types of stablecoins, starting with.
Pros And Cons Of Fiat Backed Stablecoins
- High Degree Of Certainty: Fiat Backed Stablecoins or Fiat collateralized pegs transmit the highest degree of certainty to stablecoin holders that the coin is indeed worth the asset it is backed by.
However, fiat-collateralized pegs have some major cons too:
- Capital Sits Ideal: For one, from the company’s standpoint, the asset is frozen and can’t be used for anything else.
- Collateral Risks: Also, there’s always the risk of embezzlement or the closing of the company’s bank account, which can ruin the trust in the stablecoin.
- Require Proof Of Solvency: Another issue with fiat collateralized stablecoins is that it’s hard to actually prove the company owns enough of the asset to really back the amount of coins in circulation.
Tether, for example, has suffered severe criticism and audit requests from skeptics claiming the company doesn’t have enough collateral to back the USDT in circulation.
Pros And Cons Of Crypto Backed Stablecoins
Talking about the pros and cons of Crypto Backed Stablecoins or crypto collateralized pegs:
- Easily Audited: Crypto-collateralized coins, on the other hand, may have the benefit of viewing the collateral on the blockchain.
Crypto Collateralized Pegs also have some cons too, and these are as follows:
- Highly Volatile: Collateral itself is extremely volatile. That’s why a premium is needed. In many cases that company will hold 150% or even more of the collateral needed, to make up for possible drops in cryptocurrency prices.
Pros And Cons Of Algorithmic Backed Stablecoins
- No Asset Required: Algorithmic pegging benefits from the fact that the company doesn’t need to hold any asset on hand.
- Questionable Solutions: However, many will argue that algorithmic pegging theory doesn’t really work in real life, since manipulating the money supply isn’t a guarantee the peg will hold.
What Is The Business Model Of Stablecoins?
With all of the complexities in maintaining a stablecoins peg, you might be wondering what’s the incentive to create a stablecoin in the first place? What’s the business model?
Well, for each company there’s a different incentive. Some companies can charge a fee for trading their coin. Other companies use their stablecoin as a marketing channel to raise awareness to the company and other services it offers. There are approximately 200 stablecoins available in the market today:
Houbi, Gemini, Coinbase and Circle are exchanges that have created their own stablecoins in order to attract more users to their trading platforms and allow easier transition of funds within and between exchanges.
What Are The Examples Of Stablecoins
Let’s take a moment to go over some examples of the more popular stablecoins in use today:
- Tether (USDT)
- USD Coin (USDC)
- Binance USD (BUSD)
- DAI
- JP Morgan
- Gemini USD
SDT or USD Tether, which are already mentioned, is a fiat collateralized stablecoin that is pegged to the US dollar.
The coin was created by the company Tether and has remained relatively stable since its introduction in 2015. TUSD, not to be confused with USDT, stands for TrueUSD and is a relatively new fiat collateralized stablecoin that attempts to address the criticism directed at Tether.
Collateral U.S Dollars are held in the bank accounts of multiple trust companies. These bank accounts are published every day and are subject to monthly audits.
GUSD, also known as Gemini USD, is a fiat collateralized stablecoin issued by the popular crypto exchange Gemini, which was established by the Winklevoss brothers. According to Gemini, GUSD is the first regulated stablecoin in the world. USDC, which stands for USD Coin, is a fiat collateralized stablecoin issued by Circle and Coinbase.
And finally, DAI is a stablecoin created by MakerDAO that is crypto collateralized. There’s a lot of criticism going on about the creation of stablecoins. The most common one is related to the inability of actually maintaining the peg in the long run. This could be due to any one of the reasons mentioned above.
Problems With Stablecoins
Another issue is that stablecoins seem to be providing a solution to something that is just a growing pain and not a constant problem. Once cryptocurrencies achieve a higher market cap, their volatility will reduce dramatically and there will be no real use for stablecoins. Stablecoins are trying to get the best of both worlds – the stability of an established currency with a large market and the flexibility of a decentralized, free for all cryptocurrency.
The problem is that they also get the worst of both worlds: A centralized coin with a sort of central bank controlling it and a questionable ability to maintain the public’s trust in it. Finally there’s the question of regulation – Will regulators allow companies to create an asset that mimics legal tender without any oversight?
One example for such an issue is Basis. An algorithmically pegged stablecoin that raised over $130m for its project, just to shut down due to regulatory issues not so long ago. It seems like stablecoins are some sort of a temporary utility for exchanges, allowing traders a haven out of volatility, without needing to supply them with a regulated fiat option. In the long run, it’s hard to be sure how or whether these coins will have a place in the crypto ecosystem, especially with so many question marks surrounding them.