What are Stable Coins and why are they important to the cryptocurrency market?

In the context of continuous cryptocurrency fluctuations, stable coins have emerged as a groundbreaking solution to address the industry’s biggest challenge – price volatility. From professional traders to ordinary investors, everyone recognizes that stable coins are not only a supporting tool but also an essential foundation for the development of decentralized finance (DeFi) and practical cryptocurrency applications.

This article will provide you with a comprehensive guide to stable coins – from their operating principles, different types, to real-world applications and the latest market developments.

How do Stable Coins work and what are they designed for?

Stable coins are digital assets developed with a specific goal: to maintain a stable value by linking to external references. These references can be traditional currencies (such as US dollars, euros), precious commodities, or even other financial instruments.

The reason stable coins were created is simple: Bitcoin and other altcoins often experience extreme price fluctuations in short periods. This makes daily transactions risky and unpredictable. Stable coins solve this problem by providing a medium of exchange with a relatively fixed value.

Price stability mechanisms are achieved through various methods:

Method 1: Stable coins backed by fiat reserves, supported by a specific amount of traditional currency or financial instruments (such as treasury bonds), usually at a 1:1 ratio.

Method 2: Algorithmic stable coins use mathematical formulas to automatically adjust supply and demand, automatically mint or burn tokens to maintain the target price.

Main benefits of using stable coins

Price stability – A foundation for secure transactions

The most obvious benefit is the ability to maintain a stable value, suitable for all forms of daily financial transactions. Compared to Bitcoin and Ethereum, stable coins experience fewer sharp price swings, making them more reliable as a medium of exchange.

Effective risk hedging tool

When Bitcoin and altcoin prices decline, investors and traders can quickly switch to stable coins to protect their assets. During bear markets, stable coin volumes on blockchains surge, demonstrating their important role as a “safe haven.”

Availability within the DeFi ecosystem

Stable coins are the backbone of decentralized finance. They are widely used as collateral in lending protocols, provide liquidity for decentralized exchanges (DEX), and support many other financial services without intermediaries.

Global financial inclusion

Stable coins transcend geographical barriers, allowing individuals without access to traditional banking systems to participate in the financial ecosystem. This is a significant step toward financial inclusion.

Passive income generation

Through DeFi platforms and cryptocurrency exchanges, you can earn returns on your stable coins. By holding them on lending platforms, you can earn periodic interest, creating a potential source of passive income.

Main types of stable coins currently on the market

Stable Coins backed by fiat currency

This is the largest category, where tokens are supported at a 1:1 ratio by fiat currencies like the US dollar, euro, or equivalent financial instruments such as treasury bonds. All collateral assets are stored off-chain (off-chain) by regulated financial institutions.

Tether (USDT) – Market leader:

• Market capitalization: over 83 billion USD (as of August 2023)
• Market share: over 68% of the stable coin market
• USDT operates on multiple blockchains including Ethereum, TRON, EOS, Algorand, Avalanche, and Solana
• Highest liquidity, ideal for trading on major exchanges
• Although previously controversial regarding reserve transparency, Tether has disclosed this information and undergone independent audits, increasing credibility

USD Coin (USDC) – Trusted follower:

• Market capitalization: over 26 billion USD with a 21% market share (August 2023)
• Managed by Center Consortium (founded by Circle and Coinbase)
• Each USDC is backed by a dollar reserve including cash and short-term US treasury bonds
• Regulatory approval provides a competitive advantage
• Available on Ethereum, Avalanche, TRON, Stellar, Solana, Algorand, Flow, and Hedera

Stable Coins backed by cryptocurrencies

This type uses cryptocurrencies as collateral but requires over-collateralization (over-collateralized) to counteract the volatility of the reserve assets.

DAI – Decentralized solution:

• Created and managed by MakerDAO, a decentralized autonomous organization (DAO)
• Operates on the Ethereum blockchain via smart contracts
• Uses MKR tokens to control stability
• Integrated into over 400 DeFi applications
• Market cap: over 5.3 billion USD, ranked 3rd among stable coins
• Notable for being fully decentralized, not controlled by central banks

Reserve (RSV) – Combating hyperinflation:

• A stable coin supported by cryptocurrencies but with a unique social goal
• Designed to provide infrastructure for decentralized banking in hyperinflation-affected regions
• Backed by prominent investors like Peter Thiel and Sam Altman
• Market cap: over 28 million USD
• Enables individuals in hyperinflation zones to access stable currencies like the US dollar

Stable Coins backed by commodities

These tokens are supported by tangible assets such as precious metals, oil, or real estate. Their value is pegged to the current market price of the underlying commodities.

Tether Gold (XAUT) – Digital gold:

• Each token represents one troy ounce of gold
• Backed by standard London Good Delivery (LGD) physical gold bars
• Combines the security of physical reserves with the flexibility of ERC-20 tokens on Ethereum

Pax Gold (PAXG) – Convertible asset:

• Each token represents ownership of one troy ounce of fine gold
• Gold stored securely in LBMA-approved vaults in London, managed by Paxos Trust
• Can be exchanged for Good Delivery gold bars or USD at current market prices
• Lower costs, free storage fees, with audited custodianship

Algorithmic Stablecoins – Stability through algorithms

Instead of collateral assets, these coins use algorithmic mechanisms to control supply and demand, maintaining stability. However, this approach is more complex and carries certain risks.

USDD – Algorithmic stablecoin on TRON:

• Launched on the TRON blockchain
• Uses Peg Stability Module (PSM) for 1:1 exchange with other stable coins
• Market cap: over 723 million USD, ranked 7th among stable coins (August 2023)
• Represents TRON’s entry into the decentralized stablecoin space

Frax (FRAX) – Hybrid algorithm stablecoin:

• Introduced in 2020, using a partially collateralized and algorithmic mechanism
• The Frax Finance ecosystem includes $FRAX (a 1:1 USD-pegged stablecoin) and $FXS (governance tokens)
• Unlike DAI or USDC, FRAX does not require full over-collateralization
• Supports USDC as the primary collateral asset to ensure intrinsic value
• Market cap: over 810 million USD, ranked 6th among stable coins (August 2023)

Notable emerging stablecoins

PayPal USD (PYUSD)

PayPal, a leading global financial company, officially launched its own stablecoin pegged to the US dollar. This move by a major financial conglomerate demonstrates the increasing mainstream adoption of stable coins within the crypto ecosystem.

First Digital USD (FDUSD)

Launched in June 2023, FDUSD is a relatively new player but has already gained attention:

• Issued by First Digital Group based in Hong Kong
• Available on Ethereum and BNB Chain, with plans to expand to other blockchains
• Notably: can be directly exchanged for USD, enhancing trust
• Ranked 9th among stable coins after launch
• Market cap: below 400 million USD (early September 2023)
• The surge of FDUSD is related to a major crypto exchange halting support for a competing stablecoin, advising users to switch to FDUSD before February 2024

Euro Coin (EUROC)

Circle, the issuer of USDC, announced EUROC in May 2023:

• The first stable coin fully backed by euros
• Fully exchangeable at a 1:1 ratio for EUR
• Available on Ethereum and Avalanche since August 2023

Djed – Cardano’s stablecoin

Another notable candidate is Djed, developed on Cardano:

• Market cap: over 3.5 million USD
• Rank: 1,006 by market capitalization (August 2023)

How many stablecoins are there currently?

As of August 2023, CoinMarketCap lists over 140 stablecoins on the market. From trusted names like Tether (USDT) to new entrants like PayPal USD (PYUSD) and First Digital USD (FDUSD), the stablecoin landscape continues to expand to meet diverse needs and use cases.

Risks and concerns to be aware of

Can a collapse happen?

Stable coins carry risks if they are not fully backed, well-managed, or lack transparency. The collapse of the algorithmic stablecoin UST (TerraUSD) serves as a costly lesson, raising concerns about the stability and safety of certain stable coin types.

Can stablecoins appreciate in value?

While the primary goal of stable coins is to maintain a fixed value, market factors and external events can still influence their value, causing minor fluctuations.

Frequently Asked Questions about stablecoins

What was the first stablecoin?

Tether (USDT), introduced in 2014, is widely regarded as the first stablecoin in the cryptocurrency market, aiming to maintain a 1:1 peg with the US dollar.

Which stablecoin is the best?

There is no absolute “best” type. The choice depends on specific use cases:

• USDT: Highest liquidity, widely accepted
• USDC: Safe, tightly regulated
• DAI: Decentralized, no intermediaries
• USDD: Performs well on TRON

Are stablecoins regulated?

Stablecoins are increasingly under scrutiny by regulators due to their potential impact on the financial system. While no unified regulation exists, many jurisdictions are developing their own frameworks. For example, the Monetary Authority of Singapore (MAS) finalized its regulatory framework in August 2023, requiring issuers to maintain necessary reserves.

Can stablecoins be stored on hardware wallets?

Yes, you can store stable coins on hardware wallets like Ledger. This is a secure offline storage option for those who want to keep their stablecoins safer.

Conclusion

Stable coins have become an essential component of the cryptocurrency ecosystem. By addressing the issue of price volatility – the biggest barrier to digital asset adoption – stable coins provide a reliable medium of exchange and support real-world financial applications.

As cryptocurrencies continue to gain acceptance and usage worldwide, stable coins will remain central in shaping the digital financial landscape. They are not only supporting tools but also bridges between traditional finance and the future of decentralized, inclusive, and accessible finance.