In the middle of the highly fluctuating cryptocurrencies there exist a few such tokens that are not irregular. What are these tokens and how is that they remain calm amidst the storm.
The crypto market is known to be very volatile and that is exactly why we don’t use it for day to day transactions. The reason for this volatility is the small market cap. The smaller the market cap, the greater is the volatility. In the long run, we can expect larger market caps that will induce price stability and we could use it for everyday purchasing but for now
To deal with this we have something known as Stable Coins. These coins, as the name suggests, try to maintain a stable price.
Such coins were created in an attempt to create a cryptocurrency that is not so volatile. This was achieved by pegging the token to another asset. like DGX to gold.
But the real question is how? How do you peg a digital coin to real-world currency and what is the price we have to pay to achieve this stability.?
To peg a token to a fiat currency, cryptocurrency producers must be able to back up their claim, generally by keeping that cash in reserve at all times. The reasoning is that if the cryptocurrency fails for any reason, the cryptocurrency tokens that investors hold are truly worth $1 each (in the case of Tether) if they can then go to the creators and collect their portion of fiat cash in return.
The asset, to which it is affiliated, must be held in reserve, usually by a third party.
Now, there are different types of stable coins -
Fiat collateralized
The value of this type of stable coin is based on the value of the backing currency, which is held by a third-party regulated financial entity. Generally in this case the ratio between the fiat and the token is 1:1.
Example- Tether
Crypto-collateralized
These stable coins enable the use of crypto assets as loan collateral. For example — the coin Dai is backed by Ethereum. Stable coins reduce price fluctuation by guaranteeing that each coin is completely backed by a reserve of the crypto asset. Through a system of smart contracts, and do not rely on any centralized third party.
These coins need to be overcollateralized (due to the volatility). More the volatility, the higher the collateralization ratio.
Non- collateralized
This is more of an algorithmic control. The method has been used by fiat currencies for decades where central banks use it to control the money supply.
The value of non-collateralized stable coins is determined by supply and chain which is done by coding this logic into smart contracts.
Stable coins are exposed to the same volatility and risk as the underlying asset. If the backed stable coin is decentralized, it is largely safe from predation; whereas, if there is a central vault, it may be stolen or suffer a loss of confidence.
Criticism around pegging is that such currencies will fail eventually because of the cost of maintaining them.
Example -The Bretton Woods System in which the USD was pegged to gold, this system collapsed in the 1970s.
So what’s the incentive for coming up with stable coins?
Blockchain startups create their own tokens and ICOS or they hold such crypto funds to secure their crypto assets. Companies that create their own tokens can charge a fee for trading their coins.it can also be used as a way of marketing and to raise awareness about the company and the other services that it offers.
Coin trading apps like Coinbase also have their own coins to attract more users to their trading platforms to allow easier transition of funds within and between exchanges.
For somebody who trades in crypto, stable coins can be used to trade volatile cryptocurrencies to lower the risk.
Stable coins enjoy the best of both worlds i.e., the convenience of crypto and the stability of fiat. But it also comes with the worst of them. The criticism around them is that they are not truly decentralized as they have a regulatory body kind of controlling it.
Whether these stable coins be a part of the digital finance in the future is doubtful but for now they exist and they can help people if they use it properly and it is definitely a step towards a wider acceptance of cryptocurrencies.
