Stablecoins - What Are They and Why Are They Needed?
It is difficult to find somebody who hasn’t heard about cryptocurrency. Most people know that cryptocurrencies are highly volatile. So, if one invests in it, one can either earn a lot or lose a lot. It means that the crypto world is highly unstable. To make it more attractive for investors and traders, some stability is needed.
Stablecoins were created with the aim to provide this stability. Stablecoins are cryptocurrencies that have a stable value. Normally, a stablecoin’s price is pegged to another asset - a physical one, such as a piece of gold, or fiat money. A peg to the most popular fiat currencies (EUR, USD) is the most common.
Stablecoins Types
Stablecoins are classified into three main groups based on the way how the peg is ensured:
- Fiat-collateralized
- Crypto-collateralized
- Algorithmic
Fiat-collateralized stablecoins
As the name implies, such coins are collateralized by fiat currency. For example, if a company releases 1,000,000,000 stablecoins to the market, they shall be backed by fiat money. Fiat reserves are kept in special accounts. This way, all stablecoins are redeemable for fiat whenever users want to swap them.
The collateral reserves are stored in special custodial accounts and are audited constantly by third parties. It is done to ensure that all coins are collateralized, and users’ investments are safe.
USDT, USDC, and BUSD are the most popular stablecoins.
Crypto-collateralized stablecoins
Stablecoins can be collateralized not only by fiat or a physical asset. They can be collateralized by other cryptocurrencies. Usually, more popular cryptocurrencies such as Bitcoin or Ethereum serve as collateral. As we know, cryptocurrencies, even the most popular ones, are highly volatile. Their prices can go up and collapse rapidly. That’s why backing up any asset with crypto is risky. This is the reason why all crypto-collateralized stablecoins are over-collateralized. It means that companies operating crypto-collateralized stablecoins shall have in their reserves cryptocurrency whose value exceeds the value of stablecoins that circulate in the market.
DAI is the most popular crypto-collateralized stablecoin.
Algorithmic stablecoins
These stablecoins may or may not be collateralized. Their price is kept stable by an algorithm. The algorithm controls the coin supply depending on demand. If the demand grows, the algorithm works in a way to issue more coins and thus prevent their price from growing. If the demand drops, the algorithm prevents new coins from being issued or burns some coins to keep the price stable.
TerraUSD was the most popular algorithmic stablecoin before it lost its peg in May 2022, and the entire Terra-LUNA ecosystem crashed.
While the idea of algorithmic stablecoins is promising, many aspects shall be considered to make it all work as expected. Maybe in the future, after many efforts and errors, a perfect algorithmic stablecoin will be developed.
Tether as the Largest Stablecoin - What Its Perspectives Are?
Tether is among the most critical coins in crypto trading. This is a fiat-collateralized stablecoin. This asset takes third place in the crypto market based on market capitalization.
Even though the market capitalization of USDT dropped dramatically after the TerraUSD collapse, the coin managed to keep its position among the leaders. Now, the situation has stabilized.
Even though Tether has had issues with financial authorities in the past, everything is settled for now. The coin is backed 85% by cash, cash equivalents, commercial papers, and short-term deposits. The other 15% are backed by “other investments”. The company though has never disclosed what types of investments those are.
Tether is not decentralized. The company behind USDT is called Tether, and it decides when coins are issued or burnt. This is another point to consider when choosing to invest in Tether.
Stablecoins - Do They Pose Any Risks?
While stablecoins were invented to provide some stability to the crypto ecosystem, they pose some risks to the crypto world. Stablecoins are widely used for trading. Thus, they are mostly held by large investors.
In case of an emergency, it will be enough for several large wallets to dump Tether to dry out liquidity from a big part of the ecosystem. It can disrupt trading activities and send the crypto prices down.
Another concern is regulation. Considering the very high market capitalization of stablecoins, their influence on the crypto ecosystem is immense. That’s why regulation is needed at least in the sector of collateralized stablecoins.
Most stablecoins are centralized and thus, the main advantage of cryptocurrencies compared to fiat money - decentralization - is eliminated.
Even though stablecoins run on a blockchain, their performance still cannot be compared to the performance of traditional currencies. Blockchain technology is still not developed enough to process effortlessly and safely as many transactions as, say, VISA does.
Therefore, even though stablecoins have immense potential, they are still not developed enough to replace fiat money and provide the required stability to the crypto market.
FAQ
Is Tether a good investment?
Considering that Tether is a stablecoin, it is not suitable for investment purposes because its price is always equal to 1 USD
Will Tether go up?
Tether is not intended to go up. It is a stablecoin whose value is pegged to the US dollar. So, if the system works as expected, 1 USDT is always equal to 1 USD.
Where to buy Tether?
Tether is available on the majority of exchanges. It is the largest stablecoin based on market capitalization. You can get as many USDT as you need on LetsExchange.io without KYC, mandatory account registration, and no upper limits.
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