Stablecoins 101: Use Cases, Types, and Examples
In the volatile cryptocurrency market, stablecoins have become a safe haven of stability. Although not profit-oriented, they are predictable, and this is why on the Top 20 cryptocurrencies list, there are 5 stablecoins (Tether, USD Coin, Binance USD, Terra USD, and Dai).
Paving your way to profits in crypto means constant stress about its ups and downs. While you can gain thousands and even millions, losing everything is also possible.
Despite being the opposite of the coins that allow you to make fast money (or fast losses), stablecoins have nevertheless gained high popularity. One of the key reasons for this is that stablecoins allow investors and traders to profit from other coins by withdrawing their gains.
In this article, you will learn about what stablecoins are, how they are used and backed, and the examples most relevant in 2022.
What are stablecoins?
Strictly speaking, a stablecoin is a cryptocurrency pegged to the price of a fiat currency, precious metal, or another valuable asset — US Dollar, Euro, gold, silver, and so on. The stablecoin’s price strictly follows the price of the asset to which it’s pegged: for instance, a Euro stablecoin always costs 1€.
In practice, most of the stablecoins are pegged to USD, hence the price of most of the stablecoins is always $1 and does not fluctuate. The five largest stablecoins listed in the intro are all pegged by USD.
Many Dollar stablecoins are backed by the real USD at a 1:1 ratio stored securely in audited vaults. Like Tether (USDT), some of them are partially backed by securities. In the meantime, there are also stablecoins not backed by real-world assets — their price is maintained algorithmically.
The first-ever stablecoin was proposed in 2014 by mathematician Robert Sams — there was a demand for a crypto token with a predictable and stable value that could have helped deal with the volatility of Bitcoin, Ethereum, and other coins. Sams was first to introduce a mechanism of pegging a cryptocurrency to a benchmark asset. His seminal work “A Note On Cryptocurrency Stabilization; Seigniorage Shares” served as the foundation for the future of stablecoins.
Why do stablecoins matter?
The relevance of stablecoins can be easily understood by their trading volume and market cap. In 2021, these numbers even rose, which proves that stablecoins are inherent to the market’s growth.
Given that USD-pegged stablecoins can’t increase in price, their market cap rises as their circulating supply is expanded, hence the value of physical assets backing them. As of late January 2022, the total market capitalization of only the 5 top stablecoins equals $150 billion, which is almost 1/10 of the total $1.6 trillion crypto market. A year ago, the circulating supply of the 5 biggest stablecoins was worth $30 million.
Let’s consider the core stablecoin’s use cases — and the reasons why they are so important for the industry.
Predictability of stablecoins
Unlike all other cryptocurrencies, you can always rest assured that if you hold $1,000 in stablecoins, you are going to own the same amount tomorrow, in a week, and in a year. In comparison with Bitcoin or Ethereum, stablecoins’ prices won’t change — they are 100% predictable.
The predictability of stablecoins allows them to play an important role in investing and trading. When you want to take profit or close your position to prevent further loss, you can convert your assets into stablecoins to buy time and think carefully about what to do next. We will get back to saving with stablecoins further below.
Stablecoins are efficient as a means of payment
Stablecoins may become a widespread means of payment in the near future. Prices for most of the cryptocurrencies change too rapidly, and online stores struggle with setting prices in BTC or ETH the way that they keep reflecting the market price of an item long enough.
The Bitcoin price chart from 2017 to 2020 shows how fast the crypto can change its price.
Such volatility is the reason why many platforms refuse to accept cryptocurrencies as payment. For example, Microsoft embraced Bitcoin in 2014 but reversed its decision in 2018 due to Bitcoin’s volatility. Steam gaming platform did the same.
With stablecoins, there is no such problem. Although they are not as widely used yet as means of payment, that may change in the future. Terra (LUNA) is one of the cryptocurrency platforms that bring us closer to that reality: it allows creating numerous stablecoins pegged to local currencies to simplify money exchange for businesses across the globe. The LUNA token surged in 2021.
Reliable saving option
Stablecoins inherit the best features of cryptocurrencies and fiat money. Like other digital assets, they are transparent, immutable, and secure, they can be stored in a decentralized way that no authority can affect. Like fiat currencies such as the US Dollar, they are stable and predictable.
One of the main stablecoin use cases is that they allow saving money in moments of a market crash. Say, if Bitcoin plunges, you can withdraw your funds for stablecoins and then buy more Bitcoin for the same amount when the first cryptocurrency is in a dip.
Some services even allow raising money in stablecoins without trading. For example, our partner CoinRabbit allows you to lend Tether (USDT) or USD Coin (USDC) for a 10% APR. This is how you get a guaranteed income that covers inflation and allows you to profit without effort.
In countries with hyperinflated local currencies, stablecoins help people preserve their money. Bitcoin and other digital assets also serve as a good hedge against inflation, but they bear the risk that stablecoins are free from. And, importantly, the Dollar to which most stablecoins are pegged demonstrates a much lower inflation than that of plenty of local fiat currencies.
Faster intermediary-free remittances
Stablecoins work well when you have to make fast cross-border payments. The option is available to individual users (for instance, to those who work abroad and want to send money home) and to businesses that settle payments in other countries.
Like other cryptocurrencies, stablecoins run on blockchain and hence are available globally, meaning that payment will get from point A to point B in the same time irrespective of the distance, be it the next door or 10,000 miles away. In traditional remittances, there are a bunch of intermediaries who take days to exchange information and charge large fees to process your payment. By eliminating third parties, stablecoins allow sending money much faster and cheaper.
As demand for secure and efficient payment infrastructure is rising, the largest stablecoins remain not as easy to use for ordinary non-tech-savvy users and require minimal computer skills to operate with. Such platforms as Celo solve this problem by introducing simplified mobile-first solutions for global payments. This works well for newcomers — Celo does not only have a simple interface, but it leverages CeloUSD, a stablecoin that is pegged to the US Dollar and is hence understandable to most of the people unfamiliar with crypto.
The predictability of stablecoins makes them suitable for crypto loans. For example, in NOW Loans, you can borrow USDT for Bitcoin and other cryptos at a 50:50 loan-to-value ratio (16,900 USDT for 1 BTC at the time of writing). Because of an optimal ratio, your collateral won’t be liquidated even if Bitcoin keeps plunging (50% from the current price or less), and the stablecoins that you get can be spent for your relevant needs or reinvested in lucrative projects. This is how loans help your crypto work for you without the need to sell it.
4 kinds of stablecoins
Most stablecoins are pegged to the USD, but they are different by design — namely, the way their price is maintained. The majority of stablecoins are backed, or collateralized with another asset — fiat currency, another crypto, or commodity. There are also algorithmic stablecoins whose value is kept through sophisticated operations with balancing supply and demand.
This one is the most popular type of stablecoins, and it’s backed by physical fiat currency stored in vaults in a 1:1 ratio. There is a centralized entity that manages such a stablecoin and guarantees that enough dollars or securities are in reserve.
The perk of such stablecoins is that they have proven reliable over years. The concept of fiat-collateralized cryptocurrencies is easy to implement, and people understand how their value is maintained. However, there is also a drawback — not all organizations behind stablecoins are transparent enough. For instance, Tether is often accused of being audited not frequently enough. The centralized model leaves room for manipulation.
Also, fiat-collateralized stablecoins are not decentralized by nature and thus don’t boast all the perks of classic cryptocurrencies, bringing just a digital alternative to regular money. However, such stablecoins as Tether (USDT) and USD Coin (USDC) are the most popular ones in the crypto world, taking the 3rd and the 5th position on CoinMarketCap’s list, respectively.
This class of stablecoins is backed by other cryptocurrencies. They are much more transparent than their fiat-collateralized counterparts since such stablecoins run fully on the blockchain and their collateralization mechanism is open to everyone.
However, the risk is that cryptos that serve as collateral are volatile, and allowing them to back stablecoins 1:1 is not enough. To mitigate fluctuations of the underlying assets, such stablecoins are backed by much more collateral than it’s directly necessary. This is called over-collateralization.
One of the most popular crypto-collateralized stablecoins is Dai. This is a token of the MakerDAO lending protocol, and it’s minted as a loan currency when users bring their Ether or wrapped BTC as collateral to Maker.
Coming back to stablecoins backed by real-world assets, let’s consider commodity-backed stablecoins. Their value is maintained with physical assets such as gold, other precious metals, oil, or real estate. All these are commodities.
The distinctive feature of such stablecoins is that their price is not always $1 like in tokens from the two categories above. If a stablecoin is pegged to gold (the most regular type), its value corresponds to the gold price. Say, as of late January 2022, Paxos Gold (PAXG) and Tether Gold (XAUT) are trading around $1,840.
Purchasing such a stablecoin means diversifying your portfolio. The goal of PAXG or XAUT is to make gold more tradable since physical gold is not easily accessible to retail investors. By holding such a token, you take profit from the gold’s growth.
Algorithmic stablecoins are not collateralized by anything — their value is not backed by any asset, physical or digital. The way they are maintained resembles how central banks manage their local currencies. Algorithmic stablecoins were first described in Rober Sams’ paper back in 2014, but the first implementation was launched in 2018.
Here’s how it works: let’s say a coin is pegged to the US Dollar and costs $1. If its price rises, this means so did the demand for the token. To return the stablecoins’ price to $1, the algorithm releases extra supply thus lowering the token’s value until it reaches $1. The opposite happens when the price goes below $1: supply is reduced, and the tokens’ price increases. This is how TerraUSD (USDT), Fei USD (FEI), and Ampleforth (AMPL) work.
5 largest stablecoins in 2022
Let’s review the most notable stablecoins in today’s market.
Tether is the first stablecoin launched in 2014 by Tether Limited, a subsidiary of the Bitfinex crypto exchange. Today, this is the most popular asset that takes over half of the total stablecoin market and is the 3rd cryptocurrency by market cap. USDT is widely used for trading both in centralized and decentralized exchanges as well as in many lending platforms.
USD Coin was created by Coinbase as an alternative to Tether. Like USDT, USD Coin is backed by real US Dollars 1:1, but it’s much more transparent for audits compared to its bigger counterpart and that’s why it is widely trusted in the community.
Binance USD was issued by the Binance crypto exchange and is actively used in its ecosystem. Usage of BUSD across Binance services gives you a number of advantages. The stablecoin was approved by the New York State Department of Financial Services. As of January 2022, BUSD is the 3rd biggest stablecoin by market capitalization.
TerraUSD takes the 4th position by market cap among other stablecoins and the 15th line among all cryptocurrencies. This is the largest algorithmic stablecoin, and it works in the Terra ecosystem — a platform that facilitates money exchange for businesses worldwide.
Dai is a crypto-collateralized stablecoin in which loans on Maker are issued. Like for the other Top 5 stablecoins, the Dai price is pegged to the US Dollar. The token runs on an Ethereum-based smart contract which was proven secure in numerous audits.
All 5 stablecoins can be traded on ChangeNOW for 350+ other cryptocurrencies. There is no need for signup and identity verification — simply choose the currency pair, send crypto to the address provided, and find the swapped coins in just a few minutes. We charge no hidden fees — they are all included in the estimated rate.
There are dozens of stablecoins in the crypto market, and their total market cap makes up a significant portion of the whole crypto domain. Stablecoins vary by the way their value is maintained — they can be backed by fiat, other cryptos, commodity, or kept stable algorithmically. Most stablecoins are pegged to the US Dollar, and the value of such tokens is always $1. Stablecoins are used in investing and trading to secure profits or avoid losses, in crypto loans, and remittances.