Exploring the Role of Stablecoins in the Crypto Market

Stablecoins are important building blocks in the world of cryptocurrency, providing stability and liquidity in the digital asset space as well as offering large-scale onramps into the traditional financial system.

Please do not confuse stablecoins with the likes of risky cryptocurrencies like Bitcoin or Ethereum as they are meant to be a token that has stable value.

This intrinsic value is why fixed money are made as one thing which should not fluctuate an excessive amount of in value over time. In this guide, we explain why stablecoins are important, the different types, and what they mean for the wider world of cryptocurrencies.

Stability and Price Pegging

Stablecoins are the type of cryptocurrencies that are meant to maintain a stable value and not to be volatile as most of the other cryptocurrencies.

By linking the value of each coin to such a stable asset or some combination of assets, the stablecoin reaches price stability.

Fiat-Collateralized Stablecoins: Backed by reserves of the fiat currency such as USD, EUR, or GBP stored in bank accounts. Examples include Paxos Standard (PAX), USD Coin (USDC), and Tether (USDT).
Commodity-Collateralized Stablecoins: Tethered to a commodity, such as gold or silver, which is locked away in storage. They provide stability simply by pegging their value to the price of the respective hard commodity. These are Tether Gold (XAUT) and DigixDAO (DGX).
Crypto-Collateralized Stablecoins: Collateralized with another cryptocurrency held in a system of smart contracts. These stablecoins use a combination of over-collateralization and algorithmically-based stabilizing mechanisms to achieve this stability. Dai (DAI) from MakerDAO and sUSD from Synthetix are two examples of this.
Algorithmic Stablecoins: Methods to stabilize the value of Stablecoins, which can range from minting and burning new or existing coins to changing their supply through governance. Look at Ampleforth (AMPL) and TerraUSD (UST) for references.

Use Cases and Applications

Stablecoins play a very important role not only within the cryptocurrency ecosystem but also in various use cases and applications.

Trading and Speculation: Stablecoins are used a medium of exchange and store of value to protect against shorter-term volatility better than a traditional cryptocurrency or fiat currency.
Remittances and Cross-Border Payments: Stablecoins are used to perform cheap cross-border transactions, which helps in empowering people and businesses to transact globally, without banks taking any part in the process of payment.
Decentralized Finance (DeFi): Stablecoins form the base layer of collateral, liquidity, and trading pairs for decentralized finance protocols, which enable lending, borrowing, yield farming, and synthetic asset creation.
Tokenization of Assets: In a way, stablecoins can also serve as a representation of real world assets such as real estate, securities or commodities through tokenization, where this tokenized real world asset can be shared (fractionalized), transferred and most importantly turned liquid.
Merchant Payments and E-Commerce: Stablecoins present merchants and consumers with a stable, cross-border payment solution for e-commerce, reducing dependence on traditional payment processors, and enabling quick settlements.

Regulatory Considerations

While having many potential benefits, stablecoins may also present regulatory risks in the areas of transparency, consumer protection, anti-money laundering (AML), and even financial stability.

Stablecoin is now going under the microscope of regulators and policy makers globally, looking for a wide-ranging regulatory framework to deal with these concerns and at the same time, to promote innovation and improve consumer confidence in the market.

Market Impact

Stablecoins, in turn, have found themselves at the crux of critical components of cryptocurrency market infrastructure, impacting liquidity, market efficiency, and a path to scale:

Liquidity and Trading Volume: Stablecoins are time after time included in a huge fraction of the complete trading volume concerning cryptocurrency exchanges, being the essential trade pairs with which cryptocurrencies are traded, and besides the liquidity grows across the various trading pairs.
Market Arbitrage and Efficiency: It makes arbitrage possible and market-efficient for traders on both sides of BTD/USD at the same time, hence market makes it more efficient in the price discovery and pricing of BTD across different exchanges.
On-Ramps and Off-Ramps: Stablecoins act as the main on-ramp to the cryptocurrency space allowing users to enter and exit the system easily and in a decentralized fashion.

Future Trends and Developments

As we look towards the future, we can anticipate a number of additional changes that will come to the role of stablecoins in the cryptocurrency market, driven by technological progression, regulation, and the dynamics of the market:

Interoperability: While there are current works towards making stablecoin protocols and blockchains friendly to each other which eventually could allow for better cross-border payments and integrations with traditional finance systems.
Innovation in Algorithmic Stability: The development of additional algorithmic stablecoins and decentralized finance (DeFi) protocols will help to advance a range of alternative algorithmic approaches to stability and scaling that are less reliant on centralized collateral.
Regulatory Compliance: Issuers and operators of stablecoins will come under heightened scrutiny due to regulatory obligations, instructions regarding transparency, the backbone to comply with AML/KYC legislation, and full cooperation with the regulatory system.
Integration with CBDCs: collaboration between stablecoin issuers and central banks that introduces stablecoins as compliments to central bank digital currencies (CBDCs) and could result in greater efficiency and interoperability and the adoption of digital currencies within the international financial system.

Conclusion

This is mainly because stablecoins bring an amount of stability, liquidity, and utility into the cryptocurrency market ecosystem, making it usable for traders, investors, and businesses.

Stablecoins have the power to bridge traditional finance and decentralized ecosystems, which is why they will continue to push forward more innovation, adoption, and interoperability across the digital asset sector.

Regardless, stablecoins are here to stay, pop or not, as our regulatory frameworks change and technology marches forward to enable the future of finance.