First of all, we need to deal with the question, what makes a token a currency?
A currency should have the function of a medium of exchange, the function as a unit of account, and the function to store value. For many coins, it is a challenge to fulfil all criteria. Inflation and economic crises are the triggers for the fluctuation of value, and they are more common in our mother economy every day. Most cryptocurrencies also have only a limited function in storing wealth, making daily fluctuation that can reach up to 20% in some cases a big issue for new mediums of exchange.
If you spend a lot of time investing in Bitcoin or Ethereum, you may come across the term stablecoin. But what is it? Stablecoins are also called linked cryptocurrencies. The name already explains what this type of currency is all about: they are linked to a fixed asset and thus also secured. For example, most are tied to the value of the US dollar and therefore, one stablecoin is equivalent to one US dollar. Stablecoins act as a link between the digital crypto world and the analogue world. Currencies like the Euro or US dollar are fiat currencies in the crypto world. Stablecoins can settle payments in the fiat present using the blockchain infrastructure. This cryptocurrency, like most others, is not state-organised.
But what makes stablecoins special?
The money invested in this token always remains in the cryptocurrency cycle and can be invested in other cryptocurrencies at any time. Also, no other person is needed as an intermediary to process transactions. It saves time and money, as transaction fees are eliminated. Some crypto exchanges even offer the possibility to earn money in the form of crypto interest when holding and lending stablecoins. As the name suggests, this currency is stable and fluctuates very little compared to Bitcoin and Ethereum.
Types of stablecoins:
Stablecoins do not always necessarily have to be linked to a currency. Commodities and other cryptocurrencies can also protect the stablecoin against a loss in value.
- Fiat-linked stablecoins: the value of a coin is pretty much equal to one US dollar and is controlled by the companies that release them.
- Crypto-linked stablecoins: as cryptocurrencies have large price fluctuations, there is an additional hedge to compensate for these fluctuations. Companies do not control this type of stablecoin, and the investment is connected with a higher risk.
- Commodity-linked stablecoins: the commodities are precious metals such as gold, real estate or oil. This type is very safe as the collateralisation is done with physical assets.
- Algorithmic stablecoins: these are uncoupled and have no linked asset. A computer algorithm creates more coins when demand is high and buys up the excess supply when demand is low, which prevents the value from fluctuating too much.
Top 3 stablecoins:
- Tether-USDT: the third largest cryptocurrency in terms of market capitalisation and also one of the oldest stablecoins.
- DAI: the second largest decentralised stablecoin by market cap.
- USD Coin (USDC): one of the most secure stablecoins.
The risks of stablecoins:
Stablecoins are often not that popular among investors as there is little chance of potential increases in value, unlike other cryptocurrencies. In addition, stablecoin markets screen customers, which does not guarantee anonymity. When buying a fiat-linked stablecoin, the buyer places a lot of trust in the respective company. The purchase process is centralised, and all support lies with the project owner. It is therefore recommended to thoroughly study the history of the company and its owner before buying.