Stablecoins and their role in the cryptocurrency market

As seen from the name, stablecoins are a specific sort of cryptocurrency which maintain a stable value and are pegged to some asset or a set of assets (fiat currency, valuable products or other crypto). It helps them to avoid high volatility which plague traditional cryptocurrencies, as they are backed by reserves of the assets they are pegged to. Stablecoins are supposed to be an answer to cryptocurrency fluctuation, as they are seldom affected by market dynamics, which makes them more attractive for some investors. They may also act as a kind of ‘medium of exchange’ or a store of value for the users, which is important in maintaining stability.

But how are they different from traditional cryptocurrencies? The first and foremost difference is the low volatility, since their main aim is maintaining value. Secondly, the issue of these coins can be unlimited (at least, in theory). An authority or organization may issue any amount of stablecoins, whilst cryptocurrency issuing has certain limitations. Then stablecoins are virtually invulnerable to artificial price fluctuations (the pump and dump scheme in particular) and resistant to crashes of the market. On the other hand, it is hard to make profit on exchange rate fluctuations with stablecoins.

Types of stablecoins

There are several types of stable coins grouped according to different parameters.

Stablecoins are divided by the control system into centralized, which are issued and controlled by a certain company or group (for example, Tether or Binance USD) and decentralized, which are not controlled by a specific authority (for example, LCX).

By collateral they can be fiat-collateralized, cryptocurrency-collateralized and commodity-collateralized. Fiat stablecoins are backed by fiat currency (such as dollars or Euros), for example, USD Coin. The volume of collateral assets ought to correspond to the amount of coins in circulation. They are popular among users who invest in cryptocurrencies or take part in trading, and are used for receiving profit and accumulation. Cryptocurrency-collateralized stablecoins, such as DAI, are backed by some other cryptocurrencies (such as Ethereum or Bitcoin). These stablecoins are popular among venture investors and developers, while retain investors use them mostly for long-term investment. Commodity-collateralized stablecoins are backed by commodity reserves (such as precious metals), an example of theses is PAX Gold.

There is also a type of stablecoins called Algorithmic. Algorithmic stablecoins have no backing of any physical asset and their values are maintained by a specific complex algorithm, for example, Basis or Ampleforth. Their exchange rate changes automatically according to demand-and-supply rate.

Pros and cons of stablecoins

As any type of coin, stablecoins have their benefits and drawbacks.Among the benefits of using stablecoins are the following:

• Stability. The main benefit of stablecoins, which makes them so attractive, is their stability and resistance to market crashes (compared to traditional cryptocurrencies). Users who seek predictable profits and investment returns are attracted by this feature. Their sudden disappearance is highly unlikely, as long as they are backed by assets with real value.
• Transaction speed. Stablecoins are convenient for quicker and cheaper cross-border transactions. They do not succumb to certain restrictions which are common with traditional cryptocurrencies and have no limitations inherent with traditional currencies and assets, which makes them a more flexible option.
• Privacy. Transaction operations with stablecoins are usually carried out on decentralized platforms, where users do not need to reveal sensitive and personal information, which offers users privacy.
• Decentralization. The majority of stablecoins are issued and traded on decentralized platforms, which reduces the possibility of their control by government or other limited authorities. It offers a higher degree of autonomy.
• Convenience. Stablecoins are very convenient for value storage for any periods of time and are available at any type of crypto exchanges. They may form trading pairs with almost any cryptocurrency and choosing such a platform is much easier than trading coins for traditional currency.

On the other hand, there are some certain drawbacks of such attractive means of investment:

• Centralization. While most stable coins are traded on decentralized platforms (and they were actually designed for that), some of them are issued and controlled by specific authorities. It brings about a risk of price manipulation (by means of controlling the reserve of underlying assets). Issuing centralized coins by some authority or organization reflects their exchange rate.
• Security and regulation problems. Being unregulated, stablecoins can not offer users protection by the local consumer protection laws. The banks where underlying assets are kept can be robbed or suffer from other issues, which will cause certain problems to stablecoins’ users.
• Counterparty risks. In some cases users should trust third-parties holding the reserve of assets which back their stablecoins. This leads to so-called counterparty risks, because users must rely completely on the honesty of such third parties. If the company or organization, which issues the coins, has problems, it will affect the reputation and exchange rate of the stablecoins.

Impact on the market and volatility

On the whole, how can stablecoins affect the market of cryptocurrency? First, their stability leads to fast growing adoption of them, which helps to make the cryptocurrency market less volatile. The ability of stablecoins to make trading pairs on crypto exchanges allows moving funds from cryptocurrency to stablecoins and back again to escape the outcomes of high market volatility. Cross-border transactions with stablecoins become faster and require lower fees, and allow avoiding slow and expensive traditional remittance services. Stablecoins help to bridge the gap between traditional currencies and crypto, attracting new investors and acting as a convenient means of payment for business. Stablecoins can also protect users’ savings from the outcomes of a country's monetary value drops and inflation and provide confidence and security.