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Cryptocurrencies are notorious for being highly volatile. Whenever you look at the crypto charts you will see that prices go up and down significantly every second, which can be seen as both positive and negative. But one thing is certain, no financial market can grow without having a stable currency that people can depend on. For example, in Forex we have the USD, in commodities we have gold, so what do we have in crypto?
In crypto, stablecoins take up this mantle and they are used for a wide range of stuff. While Bitcoin is the king of crypto and Ethereum is the largest blockchain, many can argue that stablecoins hold the same importance to this ecosystem as these two and there are certainly arguments for it. So what exactly are stablecoins and how do they remain stable in the volatile crypto space?
Stablecoins are cryptocurrencies that are pegged to certain assets and maintain a stable value. When it comes to the currencies that these stablecoins are pegged to, there can be both traditional currencies such as the USD, and other cryptocurrencies as well. When stablecoins are pegged to different cryptocurrencies, these tokens are called wrapped tokens and they are essentially the copy of certain crypto but operate on different blockchains. For example, Wrapped Bitcoin is Bitcoin that can be used on the Ethereum chain, and despite this, its value exactly resembles Bitcoin’s.
But when mentioning stablecoins, most people don’t mean these warped tokens, but cryptocurrencies that are pegged to regular fiat currencies. When a stablecoin is pegged to fiat currency like the USD, this token always maintains a $1 value and never exceeds or falls significantly under $1 and its price movements are usually less than a cent. So how do they maintain this value?
As we mentioned stablecoins are pegged to different currencies and this helps them maintain their value, but what does it mean to be pegged? Let’s use USDT, the largest stablecoin, as an example. For every USDT that is minted on the blockchain and enters circulation, the exact same amount of USD is being put aside in the bank. What this means is that for every USDT in circulation, there is $1 in the bank allocated to each token, essentially making its value stable. This goes against the crypto’s main principles, as almost every big cryptocurrency is a speculative asset and they are never tied to any physical currency or asset.
There are also algorithmic stablecoins that embody the spirit of cryptocurrencies by not being tied to traditional fiat currencies. These stablecoins use complex mathematical algorithms and through pre-programmed supply, they match the market demand and make these stablecoins maintain a $1 value. But while these stablecoins are more closely related to regular cryptocurrencies, they are also riskier.
There is always a possibility that the algorithm will fail or people running the algorithm might take advantage of the situation and cash out a very big amount of money. A recent example of an algorithmic stablecoin failing was last year when UST lost its peg and lost people hundreds of millions of dollars.
You might be thinking to yourself, why do we need these stablecoins, especially ones that are backed by traditional assets? The answer to this question is the ease of usability. Making crypto transactions are fairly easy, as all you need is the wallet address of the person you are sending crypto to and that's it. But when it comes to making payments using cryptocurrencies, sometimes things become tricky. Since cryptocurrencies are highly volatile, most businesses are having a hard time accepting these tokens, as one day it might be worth it for them to sell something for 1 Ether, but then prices might drop, and selling the same product the next day for 1 Ether might not be profitable anymore. When using stablecoins, this problem is removed as businesses know that when they receive 100 USDT as payment, even if the crypto market crashes, this 100 USDT will still be worth the same amount. With this, people and businesses can take advantage of all the benefits brought by cryptocurrencies and avoid the volatility of the market.
Another reason that stablecoins are needed is that they can be used as a safety tool for investors. As we mentioned multiple times, cryptocurrencies are highly volatile and their prices can change significantly in a very short amount of time. Because of this, investors like to balance out their portfolios from time to time and there are times when it is best to remove certain cryptocurrencies from their portfolios. But what to do if the market is in a bad state and investing in any token will be a bad decision to make? Cashing out the extra funds can be one option, but most investors would rather not do that, since they will deposit this money back into cryptocurrencies anyways and they will be losing some money from fees. The second and best way to approach this situation is to move extra funds into stablecoins, as this will guarantee that market volatility won’t touch investors' money and their funds will remain on blockchain.
Bitcoin is not a stablecoin and its price is very volatile. Stablecoins are cryptocurrencies whose prices are stabilized by pegging them to other assets. Most stablecoins are pegged to the United States dollar and no matter what market conditions we currently face, these stablecoins will always be worth $1. While on the other hand, Bitcoin is a speculative asset that has no ties to any other asset, meaning that its price is determined by simple demand on the token and people's belief in it.
When it comes to the biggest stablecoin, USDT is considered the top dog. This is due to the fact that USDT is the most widely accepted stablecoin and it can operate across multiple different networks and blockchains. Currently, USDT has just over 75 billion tokens in circulation which give it a market capitalization of $75 billion and makes it the largest stablecoin. In the second place, we have USDC which has 37 billion tokens in circulation and just barely avoided losing its peg due to SVB’s bankruptcy.