Stableсoin is cryptocurrency with price stable characteristic — it can be either a coin with fixed rate or a cryptocurrency stable to exchange rate fluctuations. The low volatility of the rate (or its almost complete absence) is achieved by linking Stablesoins to various assets (including fiat currencies, gold, SDRs, digital currencies), or by reproducing on a decentralized basis some elements of central banks' monetary policy (the Seigniorage Shares concept).
By definition, a stablecoin is an asset — not a currency — which offers price stability characteristics. It is mainly designed to be used as a unit of account and even as a store of value.
Why do we need a StableCoin?
Stablecoins perfectly perform not only the function of the medium of exchange — thanks to the stability of the course they can also effectively act as a unit of account and a means of saving. This can allow a lot of people to receive a salary in the cryptocurrency, without fear of a sharp decline in its rate.
Stable coins can become an alternative to the fiat currency for residents of economically unstable countries. Stable coins can be effectively used in the market of crypto-currency loans and derivatives. In addition, for a long time Stableсoins are popular among traders who buy more volatile crypto currencies “at the bottoms”, and then sell them more expensively during periods of market recovery.
What are the Types of StableCoins?
Depending on the type of currency backing, it is possible to distinguish three types of stable coins:
Backed by fiat currencies (Tether, TrueUSD);
Backed by digital currency or cryptocurrency basket (BitUSD, Dai tokens);
Unbacked (Seigniorage Shares).
1. Backed by fiat currencies (Tether, TrueUSD). This type of stable coins are debt obligations. Every Stableсoin corresponds to a unit of a fiat currency held by a third party (for example, in a depositary bank). For example, a user makes the USD-denominated deposit to a bank account and receives Stablecoins in a 1: 1 ratio. When he wants to return the deposit, the issuer will liquidate the corresponding amount of his Stablecoins and return the required amount in USD dollars.
DigixDAO stable coin works in a similar way, except that this currency is backed by gold.
Advantages of fiat-backed stable coins:
- easy to use;
- 100% stability (under full support conditions);
- anti-hacking protection (as the pledge is out of the blockchain).
Disadvantages of fiat-backed stable coins:
- the participation of third parties -- a custodian holding a fiat currency;
- slow withdrawal in fiat currency;
- high degree of regulation.
2. Backed by digital currency or cryptocurrency basket. Such type of coins, as a rule, are secured by crypto-actives in a ratio exceeding 1: 1. As cryptocurrencies are highly volatile, a high collateral requirements minimize the risks of insolvency of the issuer Stableсoins during periods of market collapse.
Advantages of cryptocurrency-backed stable coins:
- there is no third party for storage of pledge;
- a higher level of decentralization;
- on-chain transactions allow to quickly regulate the offer of stable coins;
- much more liquid than Fiat-backed Stablecoins;
- a high level of transparency, there is no need in an external audit (monitoring is available for everyone).
- lesser degree of rate stability compared to fiat-backed Stablecoins;
- dependence on another crypto currency (or a basket of digital assets);
3. Unbacked Stableсoins. Stable coins may be unsecured fiat, crypto currency or some other assets
Seigniorage Shares is a concept of crypto-currencies that does not require collateral in other assets. It includes the reproduction on a decentralized basis some elements of central banks' monetary policy (the Seigniorage Shares concept).
For example, to maintain the price of a stable coin, the issuer algorithmically changes the supply of the coins.
So, if the price of "substitute USD" is higher than $ 1, the smart contract will issue additional stable coins that wil be available on the market until the price drops to the target mark. On the other hand, the issuer redeems tokens in order to maintain the price of a "stable coin" during periods of excessively low rates. If the opportunities for supporting stable exchange raite have already been exhausted and the Stableсoins price is still below $ 1, the issuer issues "Seigniorage Shares" which enable Stableсoins holders to receive in the future income from seigniorage (the issuer's profit).
The stability of such a system directly depends on demand of this type of Stable coins. This scheme can collapse if users lose confidence in the coins.
- there is no need in pledge;
- a higher degree of decentralization and independence, since there is no linkage to any fiat or crypto currencies (however, with a general decline on crypto currency market, the demand for Seigniorage Shares may decrease).
- more complicated monetary mechanism;
- need for sustainable demand on this kind of Stablecoins;
- vulnerability to crypto market turmoils (in case of a market collapse, it may be difficult to pay off such coins);
- the difficulty in assessing the monetary systems’ viability.