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Cryptocurrencies: What is a Stablecoin?

A stablecoin is a class of cryptocurrency that is backed by a reserve asset and aims to offer stable prices.

A US Dollar Bill
A Stablecoin is backed by fiat currencies or commodities (Photo by @thoughtcatalog)

Stablecoins have gained popularity as they aim to deliver the best of both currency worlds: the immediate processing, protection, and confidentiality of cryptocurrency payments and the volatility-free stable fiat currency valuations.

While bitcoin becomes the most common cryptocurrency, its valuations appear to suffer from high volatility. For example, in the last 12 months, bitcoin ranged from $3,500 to $10,500. Its current price is near $9,000.

It is normal to see the cryptocurrency making jumps of 10 percent in any direction within a period of a few hours. Even it's intraday price fluctuations can be crazy. Since volatility can be a nice thing to option traders, it can represent unseen risks for more traditional traders.

A stablecoin may be linked to a cryptocurrency, fiat currency, or commodities (such as rare metals or industrial metals) and can be traded in any exchange. Stablecoins are said to be backed by redeemable money, services, or fiat cash. Those connected to an algorithm are pointed to as seigniorage-style.

The benefit of asset-backed cryptocurrencies is that coins are stabilized by assets that fluctuate outside the space of the cryptocurrency, that is, they are associated with the underlying asset, reducing financial risk.

Bitcoin and altcoins are unlinked to the traditional economy, meaning even without quitting the market or taking refuge in asset-backed stablecoins, cryptocurrency investors can not avoid widespread price falls or sharp price swings.

Importance of Stablecoins

1,7 billion adults were unbanked in 2017, according to the worldwide Findex data published by the World Bank in 2018. Also, in 2017, China housed 225 million unbanked individuals, and in India, 190 million people. Also, the United States is not excluded from such a challenge, according to a 2017 study by the Federal Deposit Insurance Corporation ( FDIC), with 25 percent of U.S. households found to be either unbanked or underbanked. (See how Cardano be used as a common currency for Africa)

As a digital currency that can be used to make payments worldwide, Stablecoins provide the opportunity to support this large unbanked and underbanked community. Stablecoins can replace conventional currencies to allow quicker, safer, simpler, and cheaper cross-border transfers, from migrant workers who want to send money back home, to companies who make transfers to overseas suppliers or employees.

The projected global cross-border payments revenue for 2018 was $230 billion, according to the Global Payment Study 2019 by McKinsey & Company. More than 250 million individuals transfer over $500 billion in remittances per year. The estimated process of transporting money overseas in 2020 is around 7 percent. By 2030, the World Bank plans to slash remittance fees to 3 percent. In a recent webinar, Henri Arslanian, Chairman of the FinTech Association of Hong Kong, and PwC Global Crypto Chief stated that stablecoins get the potential to make a huge impact in the field of cross-border transactions.

Why do we need to use stablecoins?

Stablecoins aren't really subject to intense market fluctuations caused by other cryptocurrencies. For instance, in 2010, a developer purchased a 10,000 bitcoin (~$30) pizza. The same order cost $82 M earlier this year, all as a result of the dramatic price change of bitcoin. As a result, many organizations are suspicious of crypto as a legitimate payment tool.

For example, in 2014, Microsoft first started accepting bitcoin as payment, only to put a small stop to all of it earlier this year due to uncertainty. Although other organizations are starting to embrace crypto, widespread adoption is still far away. But at the other hand, Stablecoins exploit the advantages of cryptocurrencies, such as transparency, protection, immutability, digital wallets, easy transactions, low fees, and privacy, without losing the trust and stability guarantees that come with the use of fiat currency (such as the US dollar or Euro).

Stablecoins bring value to a variety of industries and individuals who need to make international payments rapidly and securely. People should not have to worry about sending a speculative asset in both scenarios that could suddenly decrease in value. For example, people in underbanked societies can use this type of digital currency to make transactions, particularly if they live in areas where economic instability is a frequent concern. This technology makes it possible to use a global currency which, in principle, is not subject to localized laws and circumstances. Stablecoins also provide substantial benefits across the ecosystem of financial services as a whole.

Bottom Line

The availability of stablecoins has increased at an astonishing scale over the last several months, as well as the total amount of stablecoins is projected to increase during the next years, particularly with companies like Libra, Visa, or Central Banks joining the room (See Visa published a patent for Ethereum based digital coin). Stablecoins are highly expected to pave the way for cryptocurrencies to become mainstream. Moreover, with a large global unbanked and underbanked population, and individuals and companies searching for quicker, simpler, and cheaper ways to transfer payments across borders, stablecoins have tremendous growth potential.

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