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Price volatility is one of the biggest driving factors for cryptocurrency as a speculative asset. But it’s also the reason why cryptocurrency still hasn’t displaced fiat money as the primary medium of exchange. The wild price swings do not encourage both consumers and merchants to use virtual coins for everyday transactions. After all, why would you buy a pair of shoes for a set amount of coins if there’s a possibility for your coins to increase in value by twofold the next week?
What are Stablecoins?
One solution being offered to the volatility issue is stablecoins. These coins basically work in the same fashion as other virtual coins on the market, but their value is based on an external asset. The first form of stablecoin is tied to a fiat currency like the USD. What this does is creating a monetary policy that regulates supply, thus preventing extreme price fluctuations.
Although stablecoins are relatively new to the market, they prove to be some of the hottest coins right now. Countless investors are quick to get their hands on stablecoins using cryptocurrency trading robots like Ethereum Code. Despite their increasing popularity, however, critics point out the many drawbacks that come with using them.
Three types of Stablecoins
Fiat-collateralized is the simplest form of stablecoin. It involves depositing a set amount of fiat money to serve as collateral. The coin to fiat currency ratio is 1:1. The process appears straightforward, but the downside is that it requires a central party to issue and redeem the stablecoin. In addition, regular audits are needed to keep the stablecoin fully collateralized.
Crypto-collateralized stablecoins work in a similar manner. But instead of being tied to fiat money, the stablecoin is tied to another cryptocurrency. The primary issue with this type of stablecoin is that it often requires over-collateralization. If the collateral is ETH, for example, then users might need to despite $200 worth of ETH in exchange for $100 of stablecoins. This prevents prices from fluctuating even after ETH depreciates by 20% or more. But in the event of a total collapse of the underlying asset, the stablecoin inevitably follows its demise.
Non-collateralized stablecoins, meanwhile, aren’t backed by anything except for the speculation that they will retain their value. These coins usually involve building on smart contracts that run an algorithm to control the supply of the price-stable currency. For most investors, the process proves overly complex, as it mostly involves computer algorithms rather than tangible assets.
Can Stablecoins lead to mass adoption?
In a perfect world, stablecoins have the potential of finally turning cryptocurrencies into the go-to medium of exchange. But there are plenty of hurdles that prevent stablecoins from taking off. Critics point out that even real-world currency pegs haven’t performed well, as the currency usually gets too expensive to keep for the long-term. In the case of crypto-collateralized stablecoins, users risk losing a ton of money due to over-collateralization, especially if the asset goes under.
It’s worth noting, however, that stablecoins are still young. Developers continue to evaluate the performance of stablecoins and make changes accordingly. Only time will tell whether there would be a stablecoin that features the perfect combination of privacy, security, and decentralization.