Stablecoin – a Response to Volatility

One of the key features of most cryptocurrencies is volatility, which is why their value can vary not only from day to day but literally from hour to hour if certain information motivates investors to decide to buy or sell digital money, which is why stablecoin exists as an alternative to such assets.

While this is one of the key reasons why cryptocurrencies are of interest to those looking to make a profit by charging their prices, in addition to creating uncertainty when it comes to asset value, it also complicates bookkeeping processes and the possibility of future planning.

It is for this reason that the so-called stable digital currencies, i.e. stablecoins intended for those who want to own digital assets without the risk of volatility. Stablecoins actually replicate the stability of physical currencies, while at the same time retaining other useful characteristics of cryptocurrencies that enable fast, confidential, and cheap value transfers. Their value in relation to currencies, i.e. other assets to which they are linked, does not change for a long time, and the fluctuations that occur are negligible.

Characteristics

These are cryptocurrencies that are linked to a certain physical currency or commodity exchange, that is, for now, most often to one of the world’s leading currencies, such as the euro or the dollar or gold. This property of stablecoin allows them to be used in everyday operations because it reduces the risk of sudden price movements over a short stage.

While one of the key features of “traditional” cryptocurrencies is enabling effective decentralization and independence from any monetary authority, they face high volatility, which is why stable cryptocurrencies are presented in response to this.

The key reason for the existence of stablecoin is to provide those who want to enter the world of cryptocurrencies and stay in it, in addition to volatile ones, with stable digital assets that are easier to dispose of and easier to protect against the risk of losing assets.

Like volatile cryptocurrencies, stablecoins are based on blockchain, which enables the decentralization of transactions. The value of stablecoin is indexed to the value of other financial assets.

Types of stablecoins

There are three types of stablecoins defined by the assets they are backed, so far. These are stablecoins based on fiat currencies, stablecoins based on cryptocurrencies, as well as those based on gold.

Stablecoins are most often based on the fiat currency, for now mostly on the dollar or the euro. In order for an entity to issue stablecoins, it is necessary to have capital in that currency that corresponds to the number of coins put into circulation on the market.

Cryptocurrency-based stablecoins are digital assets whose value is indexed to that of a particular digital currency, with the most common being value of bitcoin. In this case, maintaining the stability of the digital currency is guaranteed by one or more protocols, and it is additionally ensured by the request from the issuing entity that for each amount of stable cryptocurrency it should have coverage of twice the amount in its assets.

The purpose

One of the key reasons for the existence of stablecoin is the reduction of volatility, i.e. the protection of digital assets from the risk of price changes.

However, there are other reasons why part of digital assets are “moved” to stablecoins, and one of them is the reduction of conversion costs, as this allows to avoid the conversion of cryptocurrencies into often expensive physical currency, which is why exchanging one cryptocurrency for another, which reduces unnecessary costs.

Also, since there is no conversion of digital assets into physical currency, keeping assets in stablecoin allows these assets not to be taxed until converted into currency.

When it comes to representation, the share of stablecoin in the total cryptocurrency market is now around 10 percent.

* * * * *

This content was brought to you by VISA, the global leader in digital payments, whose mission is to connect the world with an innovative and secure payment network to enable individuals, businesses, and economies to grow.

Visa is the general partner of the Fintechlopedia project, an electronic glossary containing all relevant elements of digital transactions and related phenomena, situations, processes, and innovations.