Stablecoins are set to have an ever greater presence in modern society.
As a result, it’s important to have an understanding of the definitions and principles behind them as businesses and consumers begin to use them more and more in everyday life.
To help you, we’ve created a beginners guide to stablecoins which answers all of the most important questions you may have.
What is a stablecoin?
Definition: A digital currency that is pegged to a “stable” reserve asset to reduce volatility.
Those familiar with the world of cryptocurrency will know it has been a long-term hope that one day, users would be able to ‘buy a Mcdonalds with bitcoin’. However, crypto’s inherent volatility has always remained a roadblock to this and made it unsuitable for use as an everyday currency as several issues would arise for both customers and businesses alike.
These are cryptocurrencies that are ‘pegged’ to the value of a fiat currency (USD / GBP), a cryptocurrency (BTC / ETH) or a commodity (precious metals / oil). The issuer of these stablecoins maintains a reserve stock of the currency. If the stablecoin is pegged to pound sterling, this would mean a reserve of one pound for each coin. Their prices remain ‘stable’ as the issuer who created them will buy and sell each for precisely £1.
Pragmatically, stablecoin prices can deviate from ‘true’ fiat values but again, volatility is minimal and temporary. Despite their peg, all stablecoins share a common goal: to harness the benefits of blockchain-based digital assets in a currency that isn’t susceptible to high levels of volatility.
Are there different types of Stablecoin?
Absolutely – not all stablecoins are the same.
Although they are defined by the fact they are pegged to a separate reserve asset, the assets which they focus on differ and the mechanisms by which they maintain their stability aren’t always the same.
The 4 major types of stablecoins are:
- Fiat-backed stablecoins
- Crypto-backed stablecoins
- Commodity-backed stablecoins
- Algorithmic stablecoins
We’ve created explanations of these 4 types below:
Fiat backed stablecoins are digital assets that maintain financial reserves in fiat currency held by regulated institutions such as banks.
Some examples are:
- USDT – Tether Cryptocurrency (Started in 2014)
- USDC – USD Coin (Started in 2018)
- BUSD – Binance USD (Started in 2019)
- GBPT – Poundtoken (Started in 2022)
- EUROC – Euro Coin (Started in 2022)
They are the most common and trusted type of stablecoin. The stability of fiat-backed stablecoins is reliant on transparency and adequate reserves.
To read more, check out our full deep dive on fiat-backed stablecoins here.
Crypto backed stablecoins are a variety of stablecoin which collateralize crypto assets using an electronic vault system. Most commonly ‘Ethereum’ is the collateral used.
Commonly used ones include DAI (DAI) which is pegged to USD (USD) but backed by Ethereum (ETH).
These stablecoins are inherently more decentralised than their fiat-backed counterparts but suffer in other ways.
To read more, check out our full deep dive on crypto-backed stablecoins here.
As their name suggests, commodity backed stable coins are collateralized with real world assets such as precious metals, real estate and oil.
They are preferred by investors who prefer a more reliable form of collateral with gold and silver being the most commonly used by way of their stablecoins PAXG (Pax Gold) and SLVT (SilverTokens).
- PAX Gold (PAXG)
- Tether Gold (XAUt)
- SilverToknes (SLVT)
These stablecoins are also less susceptible to inflation compared with fiat backed stablecoins and make a good choice for those looking for exposure to precious metals but don’t have direct access.
To read more, check out our full deep dive on commodity-backed stablecoins here.
This type of stablecoin is reliant upon an algorithm that pegs itself to a physical currency. They are not fully backed by collateral but instead rely on the laws of supply and demand to maintain their 1:1 price peg.
Should the demand for the stablecoin increase and surpass the $1 peg, the protocol issues a fresh supply of stablecoins to reduce the price back to peg, to limit volatility. Let’s take FRAX as an example.
- Magic Internet Money (MIM)
- FRAX (FXS)
Algorithmic stablecoins function as ‘central banks’, defending the peg of their currency. If FRAX is trading above its peg ($1), the protocol decreases the collateral ratio to mint FRAX so less USDC is needed (as it is collateralized by USDC). Likewise, if FRAX is trading below peg, the protocol will increase the collateral ratio to prevent a UST-like event.
To read more, check out our full deep dive on algorithm-backed stablecoins here.
Benefits of Stablecoin for Business
Businesses can make use of stablecoins in many ways.
For example, they can provide:
- B2B payments settled in real time
- Cheaper cross-border operations due to a huge reduction in transfer fees
- A broader market due to worldwide usage and accessibility
- Open doors to exposure to digital assets
- New business models: e.g. NFT & charities
- Real-time gross settlement for multinational businesses
Stablecoins are borderless, which means they can easily be transferred anywhere worldwide assuming the recipient is prepared to receive the transfer. Many banks have a flat fee for processing international transfers and may take a percentage of the transaction.
This alleviates the need for ‘24/7/365’ support and eliminates the need for a third party or intermediary to take a percentage of the payment. Stablecoins mitigate these costs as transaction fees only make up a fraction of the total being sent.
To read more, check out our full deep dive on benefits of stablecoins for businesses here.
Benefits of Stablecoins for Retail Consumers
Businesses aren’t the only ones that stand to gain from stablecoin usage. Retail consumers can benefit greatly from the use of stablecoins in everyday life.
For example, they can provide:
- Low fee payments when abroad
- Greater accessibility to global commerce markets
- Ease of payment for cross-border services
- Greater safety and transparency of transactions
From everyday purchases, engaging in entertainment to entire countries retaining more of their wealth, stablecoin use cases for retail consumers are growing as the technology becomes further integrated with modern societies.
With inflation diminishing the worth of assets, including cash, stablecoins act as a hedge and a safe haven for those looking to retain as much of what they own as possible. As currencies and real world assets (RWAs) succumb to rising costs of living, stablecoins see minimal risk due to them having full custody of their assets and thus solidifying their backing of their coin. Recent examples of countries’ currency (Venezuela, Zimbabwe) becoming obsolete and/or worthless are a stark reminder of how powerful and useful stablecoins can be.
To read more, check out our full deep dive on benefits of stablecoins for consumers here.