Stablecoins are an important part of the cryptocurrency infrastructure but what makes them important? Cryptocurrencies have taken the world by storm. Back when cryptocurrencies were launched, the whole world was skeptical but now after the second bull run in 2021, institutions and individuals alike have realized the potential this technology holds. Bitcoin – the king of the market – is expected to soon reach $100,000 and that is a conservative estimate. So, another explosion is likely. The blockchain technology has numerous use cases other than the finance world. Curated blockchains cater to data & identity, supply chain management, and so much more. Cryptocurrencies are believed to become if not the mode of payment, then the alternative currency.
Why are stablecoins needed?
However, every technology is a double-edged sword. Where on one side, investors and users crave about the benefits of decentralisation, the other end of the argument cannot be ignored. Cryptocurrencies – although have use-cases – are highly speculative assets. Unlike fiat currencies which have a government behind it with equal reserves, cryptocurrencies are not backed by anything. This makes them highly volatile. The volatility and high riskiness give cryptocurrencies high-profit potential.
There is nothing wrong with cashing in on the volatility of cryptocurrencies but the problem arises when these digital assets are considered to back the global financial ecosystem. While speculation about cryptocurrencies becoming the mode of payment in the future digitized world exists, volatility acts as a hinderance in that vision.
This is where stablecoins step in. Stablecoins are essentially cryptocurrencies with the same algorithms but their value is pegged. This makes them stable and; hence, suitable for payments. Stablecoins can be pegged in four different ways:
- -Fiat-backed
- -Cryptocurrency-backed
- -Algorithmic
- -Commodity-backed
Fiat-backed stablecoins are, well, fiat-backed. Dollar is the most common currency which is used for these stablecoins. There is usually a central authority behind these stablecoins which ensure they have enough currency reserves for the stablecoin to stay pegged. Cryptocurrency-backed stablecoins offer more decentralization and work through smart contracts but a downside to this kind is that a much higher amount of collateral cryptocurrency has to be provided to ensure the backing in case the price of the collateral cryptocurrency falls.
Algorithmic coins are not backed by any asset but their value is maintained at a set price through smart contracts. These stablecoins are minted or burned to ensure the value stays pegged. Lastly, commodity-backed stablecoins are collateralized using physical assets like precious metals.
Why makes them important?
Stablecoins are important because they offer the perks of cryptocurrencies minus the loathed volatility. Although they may not pose a good investment potential, stablecoins bring hope for cryptocurrencies. The prospect of stablecoins is attractive because they have the potential to become the future of payments.
