With volatile upswing and downswing cycles occurring on a day-to-day basis, it seems almost impossible for cryptocurrencies to be stable. Yet, such tokens do exist — they’re what we call Stablecoins. Here, we’ll discuss what stablecoins really are, how they work, and why we should even care about these tokens at all.
What’s the whole point of stablecoins?
Cryptocurrencies are infamous for their high levels of volatility and fluctuating prices. In many ways, this can be a stumbling block against cryptocurrency’s adoption into the mainstream. The value of 1BTC will not be the same the next day or the next hour, making cryptocurrencies an unreliable means of transaction. The development of stablecoins seeks to target the problem, through creating tokens that are less volatile.
What are stablecoins about?
To put it simply, stablecoins are cryptocurrencies which are pegged to real-world assets like fiat, gold or oil. Being linked to these assets helps keep the value of these tokens more stable, hence, they’re known as stablecoins. Tether (USDT) is backed by the US dollar and is valued at USD$1 for each USDT token, while Digix Gold Tokens (DGX) is backed by physical gold.
The need for a central authority to step in
When stablecoins are backed by real-world assets or commodities, there’s a need for a centralised, third party to be involved. These third parties could be vendors, government regulators or the bank. With a centralised structure, the stablecoin is more prone to risks and will easily be affected if the central entity falls or goes bankrupt.
Since cryptocurrency was developed to avoid being under the control of a central authority, going back to the centralised system rubs many crypto-supporters the wrong way. Not only is there a higher risk when a central entity is involved, this system also goes against the ideological roots of cryptocurrency.
Besides stablecoins backed by real-world, physical assets, there are also stablecoins backed by other digital currencies. These are known as cryptocurrency-backed stablecoins. In general, these crypto-backed tokens are backed by a range of different cryptocurrencies and not backed by a single cryptocurrency. This distributes risk since the volatility of a group of cryptocurrencies is much lower than a single cryptocurrency.
How do you go about backing these stablecoins? Usually, users are required to stake an amount of cryptocurrencies into a smart contract. After which, the smart contract will contain the necessary details which result in creating a fixed ratio of stable coins, based on your stake.
Less volatile, doesn’t mean not volatile
While no central entity is involved with crypto-backed stablecoins, it’s still important to remember that these tokens are backed by a basket of volatile cryptocurrencies. Volatility would still be present as the base of these stablecoins are volatile tokens. Additionally, when underlying cryptocurrencies fall below a certain price, they can be easily liquidated. This would, in turn, have an impact on the value of the stablecoin.
The crypto-community is still quite divided on their vision of cryptocurrency and what role it should ideally play in our world today. Currently, not every crypto-enthusiast believes that cryptocurrencies should become part of the mainstream mode of transaction. However, if that’s the ideal goal eventually, it’s important to solve the problem of volatility. Stablecoins are not a perfect system but its development is pushing the crypto world towards increased stability.
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