Stablecoins have emerged as a unique category of cryptocurrencies, offering a more stable value and reduced volatility compared to other digital assets. This article explores the concept of stablecoins, their underlying mechanisms, and their growing popularity among crypto traders. However, as stablecoins gain momentum in the crypto market, they also face increasing scrutiny from regulators due to their potential impact on the financial system.

How Stablecoins Achieve Stability

Stablecoins maintain their value stability by being backed by real-world assets. Unlike “conventional” cryptocurrencies, stablecoins are linked to tangible assets, such as commodities like gold or fiat currencies like the U.S. dollar. This backing ensures that the stablecoin’s value remains relatively steady, making it a more reliable and less volatile option for investors.

Types of Stablecoins

There are three main types of stablecoins based on their stabilisation mechanisms:

Fiat-Collateralised Stablecoins

These stablecoins are backed by reserve assets like fiat currencies, most commonly the U.S. dollar. Examples include Tether (USDT) and TrueUSD (TUSD).

Crypto-Collateralised Stablecoins

Backed by other cryptocurrencies, these stablecoins are over-collateralised to mitigate the risk of price fluctuations. An example is MakerDAO’s Dai (DAI), which is pegged to the U.S. dollar and backed by Ethereum (ETH) and other cryptocurrencies.

Algorithmic Stablecoins

These stablecoins maintain stability through algorithms that control the coin’s supply. However, they lack the backing of reserve assets and are subject to higher risk. An example is TerraUSD (UST).

Key Features and Benefits of Stablecoins

Stability

Stablecoins offer a safer investment avenue compared to more volatile cryptocurrencies.

Reduced Trading Costs

Users can pay lesser trading fees when converting cryptos to fiat currencies as compared to other cryptocurrencies.

Widely Accepted

Stablecoins are widely accepted across various crypto exchanges, facilitating quicker and cheaper transactions.

Most Commonly Used Stablecoins

Tether (USDT) remains the dominant stablecoin, with a market cap fo almost $84 billion (As of August 2023). It is pegged to the U.S. dollar on a 1:1 ratio and is commonly used for trading on major crypto exchanges like Kraken, Binance, and Coinbase. Other popular stablecoins include DAI, USD Coin (USDC), TrueUSD (TUSD), and Digix Gold (DGX).

Regulatory Challenges

The rapid growth of the stablecoin market, reaching around $130 billion, has caught the attention of regulators. In response to potential risks to the financial system, regulatory bodies like the International Organization of Securities Commissions (IOSCO) have proposed rules to classify stablecoins as financial market infrastructure. This includes stablecoins that are deemed systemically important and have the potential to disrupt payment and settlement transactions. Calls for regular audits and bank-like regulations for stablecoin issuers have also increased.

Stablecoins have garnered significant attention and adoption due to their unique feature of value stability. Backed by tangible assets or governed by algorithms, they present a safer option for investors and offer advantages in crypto trading. However, as the stablecoin market continues to expand, it faces increasing regulatory scrutiny to address potential risks and ensure financial stability in the broader ecosystem.