Unlike fiat currencies, which are mostly governed by banks or governments, cryptocurrencies aren’t issued or controlled by any monetary authorities. Cryptocurrencies have no physical existence and can be traded across the world. All this makes cryptocurrency decentralized – it’s peer-to-peer, completely digital, protected by encryption keys, and can be sent instantly and anonymously to anyone across the globe.
Simple, right? That’s where something called Stablecoin comes into play. Stablecoin is a brand new type of cryptocurrency, that promises to offer price stability and is backed by a reserve of fiat money. Stablecoin is designed to achieve resistance against the price volatility that has become synonymous with classic cryptocurrencies such as Bitcoin or Ether.
It is designed to be stable. Stablecoins attempt to offer the instant processing, privacy and security of payments that are the main selling points of cryptocurrencies, paired with the less volatile, stable valuations of more traditional fiat currencies.
Stablecoins peg their market value to a certain external reference. They may be pegged to a common currency such as the U.S. dollar, Euro or Yen – or to a commodity such as gold or oil.
The kind of short- and long-term volatility that we have become accustomed to with traditional cryptos such as Bitcoin still makes it relatively unsuitable for everyday use by the wider public. A value of currency should remain relatively stable over much longer times than Bitcoin for example has been able to. It’s not rare to see a cryptocurrency moving 10 or more percent in either direction daily, and rise or decline multiple times in a matter of months.
Cryptocurrency coin should be able to hold its purchase power and have the lowest possible inflation, to encourage spending rather than saving coins. Stablecoins are here to take a shot at a possible solution to achieve this.
The biggest factors are the reserves that back fiat currencies. They are pegged to an underlying asset, such as forex reserves or gold for example. These reserves act as collateral and this helps to keep fiat currencies’ valuations from wild price swings that cryptocurrencies are known for.
As importantly, fiat currencies are regulated by controlling authorities such as central banks or governments. Their timely market actions also provide price stability. Most cryptocurrencies lack these key features. They lack a reserve backing their value and as they are decentralized, they don’t have a certain authority to regulate and control the prices, manage the demand and supply to help maintain stability etc.
Stablecoins are here to bridge the gap between crypto- and fiat currencies. The three categories of Stablecoins are as follows:
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Stablecoins are mostly issued by companies, such as Facebook’s Libra and JP Morgan’s JPM Coin, and commercial banks with fiat currencies as the reserve, like USDC and GUSD.
A new class of stablecoins are developed by central banks of the world. They possess both the power of issuing money and stablecoin. These coins will be called CBDC – Central Bank Digital Currency. Central banks will keep their absolute power of issuing money, while also taking advantage of cryptocurrency and blockchain technology.
The fact that central banks are suddenly showing such interest in the benefits of cryptocurrencies can both be a good or bad thing for the future of crypto. CBDC will obviously not be as decentralized as a regular cryptocurrency, but also not completely centralized like fiat currencies are and have always been.
Regular cryptocurrencies also have a lot to win from the emergence of stablecoins. Volatility has been the main issue of most cryptocurrencies so far throughout the history of cryptocurrency. Complete decentralization might not be optimal after all, if cryptocurrency is ever to become a widely used (not just saved) currency. Cryptocurrency has a thing or two “to learn” and benefit from its predecessors, fiat currencies and vice versa.