Stable Coins Guide

November 2, 2018

There probably wasn’t a time in human history when there existed such a great variety of currencies. We live in the era of smart money and cryptocurrencies have assumed different features and functions. There are utility coins, transactional coins, privacy coins, platform coins, you name it. And nowadays, one category of cryptocurrencies seems to be trending: stable coins.

What are stable coins?

A stablecoin is a cryptocurrency that is pegged to a stable asset, such as gold or fiat currencies. This means that the price of stable coins is mostly fixed with little fluctuations, hence the term “stable”.

How stable coins work?

In order to understand how they work let us analyze Tether (USDT), the biggest stable coin in terms of market cap. Tether is pegged to the US dollar, meaning that one Tether token corresponds to one dollar. In order to accomplish this 1:1 ratio, the Tether foundation must hold an equal amount of dollars of every Tether token issued.

There is indeed some controversy regarding the matter as some people state that Tether is not transparent and does not actually hold the correspondent amount of dollars in their reserve account. Although Tether has documentation proving otherwise, reports suggest that Tether is used to artificially inflate the price of Bitcoin and that it was responsible for last years meteoric rise of Bitcoin price. But let’s leave the drama behind us and understand better how stable coins work.

Why do we need stable coins?

In accordance with a paper published in 2013 by a professor of finance of the New York University, for a currency to be useful for everyday transactions it should be able to function as a medium of exchange, a store of value and a unit of account. Most cryptocurrencies struggle to possess all of these qualities, due to high price volatility they are unable to work effectively as a store of value and a unit of account.

Stable coins, however, are able to work effectively as a currency for everyday transactions. And that is why they are used in exchanges, as it’s not always easy to move fiat in the cryptocurrency world due to regulations and restrictions. Stable coins are very similar to fiat currencies in terms of stability but can also share decentralization and security features inherent to cryptocurrencies. One good example of this is the Dai stable coin. Dai is run by a decentralized autonomous organization, MakerDao, and is a stable coin pegged against the US dollar and is completely backed by Ethereum. Stability and transparency are maintained through an autonomous system of smart contracts.

Are Stable Coins the Future?

The demand for price stability in the crypto world is high. Stable coins can definitely help with adoption and ease the use of cryptocurrencies for everyday expenses. However, they are currently in an experimental stage and most stable coins have failed in the past (they were not cryptocurrencies though). If one day a stable cryptocurrency is created that is both decentralized (no need for trusted third parties), private, and scalable, then maybe we will start to see cryptocurrencies being used in our everyday lives.

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