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What is Stablecoin? All you need to know about this Digital Currency

Stablecoin is a digital currency with a stable price. Usually Market determine the price of most digital currencies in which buyers and sellers exchange coins. In fact, the prices are determined based on supply and demand. On the contrary, Stablecoins are looking for a fixed price. Join Virlan to know more about different approaches involved.

Why is Stablecoin so important?

A cryptocurrency with a stable price can be much more useful than existing digital currencies. Digital currencies are now largely held by investors, and forecasters are looking to profit from price changes.

Few people use digital currency in the way they use dollar (salary, daily purchases, etc.). The main reason is that the price of digital currencies fluctuates on a daily basis. Here we introduce you some benefits of Stablecoins:

Fiat collateralized Stablecoins

Some benefits of Stablecoins

Stablecoins Increase global access to a stable currency

The relative stability of the US dollar is a good example. The inflation is slowly depreciating the dollar. However this gradual decline is negligible compared to rampant inflation in countries such as Argentina, Egypt and Nigeria. Inflation in these countries is more than 15% per year.

The people of these countries keep dollar bills in order to preserve their wealth. However, capital control institutions usually prevent citizens from using foreign currencies for cross border transaction.

For people living in these countries with unstable monetary systems and restrictive capital controls, a decentralized digital currency that is widely available and reasonably priced can be a viable alternative.

stablecoins and digital currency world

Stablecoin is suitable for crypto loans and derivatives markets

One of the great uses of digital currency and blockchain is its function as an infrastructure for the modern financial ecosystem with less intermediaries, costs, and mistakes.

In order for digital currency markets to form, there’s a need for stable price. Ether loans are currently prohibited in the Ethereum blockchain. Because lenders and borrowers take a lot of risk by basing their loans on ether (due to changes in the price of this currency).

Also read:

What is Stellar? An International open source payment technology

Certainly, the stability of the currency is one of the main goals of the Federal Reserve System. The reason for this goal is to rely on the price and value of the currency, which is the key to creating expectations and involvement in economic activities.

According to St. Louis Fed, price stability means that inflation is low and stable enough to not affect the economic decisions of companies and households.

When inflation is low and stable, people do not waste resources trying to protect themselves against inflation. People save and invest their capital with confidence, and thus the value of money will remain stable.

Three approaches for developing a stablecoin:

As their name suggests, the goal of stablecoin is to have a stable price or value over time. In short, there are three different approaches to achieve this:

  • Collateralized by fiat
  • Collateralized by crypto
  • Non-collateralized

the goal of stablecoins is to have a consistent price or value over time

Fiat collateralized Stablecoins

Overview

This token is a 1:1 ratio cryptocurrency backed by fiat or money.

How to run

The mechanism of this approach is almost without any special complexity. A third party receives the dollar deposits and issues one stablecoin unit for each dollar deposit. To cash each Stablecoin unit, a third party pays the Stablecoin holder $1 and burns a Stablecoin unit.

Advantages

  • Easier to understand
  • If done correctly, the value of the stablecoin will be equal to dollar’s value

Disadvantages

  • Requires trust in a third party to hold sufficient fiat collateral
  • Requires another third party to make sure appropriate amount of collateral is being held
  • Audit is slow and expensive

Projects with this structure

Tether and TrueUSD

Transparency of the third party responsible for maintaining and issuing the tokens, as well as trust in the auditor, are crucial in this approach.

Crypto-Collateralized Stablecoin

Overview

Crypto-Collateralized Stablecoins are tokens backed by other cryptocurrencies. Typically, these Stablecoins have more than 1:1 ratio with a mix of cryptocurrencies.

How to run

You can apply this approach by using another digital currency such as Ethereum. The other cryptocurrency play the role of a financial support. So you don’t have the problems of third party (like the previous approach).

However, the main problem with this approach is again volatility. Since the underlying asset, in this case, is also a cryptocurrency, it is not conventionally safe and may also be highly volatile.

the main problem with this approach is again volatility

Advantages

  • There’s no need for a third party
  • It is recorded on the blockchain, subsequently stablecoin units and liquidity decrease and increase faster
  • There’s no need for an auditor

Disadvantages

  • It is not cost-effective in terms of available capital
  • The selection process becomes complicated between several cryptocurrencies
  • If there is only one cryptocurrency, its stability and security are questionable

Projects with this structure

BitShares and MakerDAO

Also read:

Can DeFi deliver on the promises of technology? 6 rules to pay attention to

Non-collateralized stablecoins, Seigniorage Shares

Overview

This approach does not rely on cryptocurrencies or collateralized currency. On the other hand, this approach is the most complex one and at the same time the most effective approach for the ecosystem.

To maintain the stable price, a central bank has been created that maintains the currency supply using an algorithm. It balances the price while it is increasing or decreasing.

How to run

Seigniorage acts as follows. In cases where the price of each unit is more than one dollar, the central bank issues a smart contract to increase inventory, so that the price of each unit reaches one dollar.

If the price falls below one dollar, the central bank uses Seigniorage profits to buy units to reduce inventory and increase prices.

If the price of each unit still remains below one dollar after spending all Seigniorage, the central bank will issue Seigniorage shares that promise future Seigniorage to buyers. So tit will raise the capital.

Moreover, if the central bank reaches a point where the price of each currency is less than one dollar and the Seigniorage have run out, it can also sell the Seigniorage to raise capital.

Non-collateralized stablecoins, Seigniorage Shares

Advantages

  • No need for Collateral
  • It is theoretically risk free in comparison to other currencies (However, if the demand for digital currency decreases, the demand for Seigniorage shares will also decrease.)

Disadvantages

  • It is more complex
  • This approach cannot determine how flexible a coin is in reducing pressure
  • It always needs increasing future demand

Projects with this structure

Basecoin and Fragments

Conclusion

To sum up, Stablecoins are currently in experimental phase. However, its successful implementation can have a significant impact on the world of digital currency.

Above all, as interest in stablecoins increases, understanding and evaluating the risks they pose to the ecosystem will be of particular importance.

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