Understanding Stablecoins
Understanding Stablecoins
Portal’s comprehensive guide to stablecoins. Learn how stablecoins are changing the global financial landscape.
This guide to stablecoins provides an overview of this cornerstone application of blockchain technology. A recent report shows increasing demand for stablecoins, with growing circulating supply and types of stablecoins as well as growth in monthly active stablecoin users.
Developers, entrepreneurs, and enterprises continue to launch new products and services based around stablecoins to serve the demand. But what exactly are stablecoins and why are they so important to the adoption of crypto?
What is a stablecoin?
Native tokens and coins for blockchains and Web3 projects are typically highly volatile assets, making them less suitable for daily transactions like payments. Stablecoins, by contrast, are cryptocurrencies whose value is tied (also known as pegged) to the value of another asset or assets in order to create price stability. The most popular stablecoins are those tied to a single fiat currency, such as the US dollar, but they can also be tied to a group of fiat currencies, a commodity such as gold, or a financial instrument.
Stablecoins are issued by entities that maintain reserves of the pegged asset as reserves to ensure that any stablecoin owner can redeem their coin at any time without concern. Most issuers maintain overcollateralized fiat reserves, meaning they have more in reserves thanare required to redeem all stablecoins in circulation. Some stablecoins are backed by an algorithm that allows the reserves to change based on the supply and demand between the stablecoin and the reserve currency. These algorithmic stablecoins have gone out of favor since the crash of Terra (LUNA) as by nature they are undercollateralized and considered at more risk to depeg.
Common uses of stablecoins
Stablecoins are used in both unique blockchain applications, as well as to form the rails of traditional finance applications. They are best used for activities where owning assets with stable value is the core user need. Payments use cases, such as remittances and cross-border payments, are particularly popular as they benefit users not only from using a currency that maintains its value but also from the instantaneous speed and low fees attributed to blockchain. Traditional methods of performing such payments can take significantly longer and cost substantially more in fees.
Stablecoins, particularly those tied to the US dollar, are also extremely useful for people living in countries experiencing hyperinflation. Given USD is considered by many to be less risky to hold on to than their own currency, people can open digital dollar accounts that use stablecoins as the base currency for savings and payment accounts. In this circumstance, the stablecoin serves as a store of value that is more consistent than their own fiat currency and the digital account is easier to acquire than a fiat USD account.
Risks of stablecoins
Although stablecoins are less volatile than native cryptocurrencies, there are still some risks associated with their use. These risks include:
- Market risk, as stablecoins can drop below the tied value if the market loses confidence in a user’s ability to redeem the stablecoin for the pegged amount at any time.
- Counterparty risk, as a third party must maintain the collateral for the issuer. If something happens to that third party, such as going out of business, it can put the stablecoin at risk.
- Security risk, as stablecoins are still subject to hacking and theft.
- Reserve risk, as users must trust the issuer has enough reserves to full support redemption of the stablecoin.
Popular stablecoins
According to CoinMarketCap, as of August 11, 2024,
Key terms to know
Stablecoins are cryptocurrencies designed to maintain a stable value, typically pegged to assets like the US dollar, reducing volatility in crypto markets.
These stablecoins are backed by reserves of traditional currency, like USD, ensuring their value remains consistent with the fiat currency they represent.
These stablecoins are backed by other cryptocurrencies, often over-collateralized to manage volatility and maintain a stable value.
These stablecoins use algorithms to manage supply and demand, keeping their value stable without relying on physical reserves.
Stablecoins are used for trading, remittances, and as a safe haven in volatile markets, offering a stable alternative to traditional cryptocurrencies.
As stablecoins grow, regulatory scrutiny increases to ensure transparency, security, and compliance with financial laws.
