Better Than Bit? An Intro to Stablecoin

Here we are with our last entry for 2020 here, and it’s true that nearly every business seems to use their last blog of the year to do a ‘year in review’ themed or something similar entry. Normally we’d be similarly inclined but this year hasn’t been the best for anyone unless you’re a coronavirus. Then it’s been an unprecedented success. All joking aside, we are like all of you in hoping that 2021 sees all of this come to and end.

One subject that has sort of returned to the front burner these days is cryptocurrencies, and it’s gone along with increasing numbers of people thinking that the ‘new’ world will see something of a move away from fiat currencies. Not a fundamental shift, but a greater share of the currency with which goods and services are bought and paid for. Bitcoin has become a household name with this subject, but now there’s a new type of cryptocurrency on the scene – Stablecoin.

Now here at 4GoodHosting we’ll go ahead and assume that we’re like every other good Canadian web hosting provider in that there’s not a single bitcoin mining operation anywhere in the office here. But that’s not to say we don’t take an interest in this, and can see the value in a currency that’s not constantly at the mercy of international finance string-pullers and the IMF.

So instead of giving a warm glance back on 2020 when likely no one feels very warm about the year that’s past, let’s spend use this post to have a longer look at Stablecoin.

What Exactly IS a Stablecoin?

Stablecoins are cryptocurrencies that better minimize price volatility in comparison to a specific ‘stable’ asset or basket of assets. Unlike the more well-known Bitcoin, a Stablecoin is one that is representative in value for a real-world asset. That could be fiat money or exchange-traded commodities like gold. This gives them steadier and more ‘stable’ value against a target price, making them appealing for investors as well as providing the stability that is making many merchants about operating in the crypto space as it exists right now.

Their greater value in being a more viable an option as an actual currency is how they are – as the name IS intended to imply – ‘stable’ against wild, daily fluctuations in price. They also project to be more useful for products people would otherwise be paying for in cash money or on the credit equivalent of it. It’s believe that Stablecoins will also be able to be used for insurance and loans, payments and even for investments.

Stablecoins will also let people use them make payments within the framing of currencies they already know well, and quickly transfer value around the globe while trusting that there will be price stability despite the alternate payment method. This part of it is huge. By increasing confidence that they are stable enough to be used as a daily medium of exchange, consumers will be more likely to trust the technology.

How Do They Work?

A good place to start with your understanding is that there are 3 primary categories of Stablecoins:

Fiat-backedThis is the primary on, and as the name tells you it is carries valued based on crypto assets that are backed directly by a government-issued currency (or commodity like gold) with a fixed 1:1 ratio. The value of the backing currency is explicitly what creates the value of the Stablecoin.

A central issuer or bank holds a certain amount of fiat currency in reserve, and a matching number of Stablecoin tokens are issued for it. The essential part of the equation is that the amount based on the backing currency reflects the circulating supply of the Stablecoin.

This type of cryptocurrency is then of course regulated, but there needs to be a certain degree of trust with the off-chain nature of the system. That’s because there is no way for a user to be sure whether the issuer is genuinely holding the funds in reserve. As a result, the stability of a fiat-backed Stablecoin price depends on the extent to which the issuer is trusted.

Crypto-backedHere Stablecoins are issued with cryptocurrencies as collateral rather than backed by fiat currencies. The benefit here is in being able to attach them to a basket of cryptos or a cryptocurrency portfolio. The nature of the blockchain technology plays a pivotal role here, with the system depending on the use of smart contracts to handle the issuance of units, ensure governance and establish trust.

Done correctly, the benefit is with a decentralised ecosystem that is user-regulated, as opposed to one issuer or 3rd-party regulatory body that dictates monetary policy. Users have to trust that all the network participants will act in the best interests of the group as a whole, which is one of the big draws of cryptocurrencies in general.

The last thing to know about this type is that Stablecoins must be locked into a contract, which then issues the token. Also, they must be paid back into the same contract before that collateral can be returned.

AlgorithmicThese versions – AKA non-collateralized Stablecoins, have no fiat currency backing them, and have no relation to a commodity or cryptocurrency reserve. Algorithms and smart contracts manage the supply of tokens issued in order to balance out price stability, and in that way it’s not unlike the monetary policy used by central banks around the world when managing national currencies.

These smart contracts are implemented on a decentralised platform and can run autonomously, with reductions or increases to the supply of tokens in circulation determined in relation to the price of the Stablecoin and in accordance to the price of the fiat currency it tracks. When the price falls below the value of the fiat currency, the token supply is reduced. When it goes above, it’s increased.

While they aren’t collateralized like fiat and cryptocurrency-backed Stablecoins, algorithmic Stablecoins have the advantage of a pool of collateral in reserve in case of major negative events or anything similar.

Stablecoins in Crypto Market

No one’s going to suggest that Stablecoins aren’t going to play a major role in the future of cryptocurrency. They look like they’ll be integral parts of the long-term adoption and use of cryptocurrencies, and the biggest reason for that being they overcome a key barrier that has held cryptocurrencies back from being used as genuine daily currencies until now.

Specifically, that’s the currency’s massive volatility and short-term fluctuations in value. But cryptocurrencies are certainly here to stay and the big takeaway for anyone should be that Stablecoins will do away with a lot of the apprehension towards cryptos that people have because they won’t be at risk of same friction and instability of Bitcoin, and should make people more open to the future of different forms of money in an ever-more digital world.

Happy New Year to All of You from All of Us here at 4GoodHosting, and we hope 2021 brings prosperity and happiness for you.

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