Explaining Stablecoins
This is a four-part series which serves as a primer for understanding the fundamentals surrounding stablecoins. The first post in our series addresses the explanation of stablecoin.
“Stable coin” is a term used in crypto-space to describe cryptocurrencies designed to provide a simple, yet a controversial solution to a major problem for crypto holders — volatility.
The cryptocurrency market has been volatile historically, for example, imagine the situation paying $3 for snack today and finding out in a few hours that it should have been $1, these what volatility is.
“For millions of individuals, tens of millions in our view, as well as institutions, the volatility of crypto assets that we saw last year really is keeping a number of people’s on the sidelines of the cryptocurrency movement, said Garrick Hileman, head of research at Blockchain and author of the recent stablecoin report, told Business Insider
Most of the crypto-enthusiasts need the option to store funds in a place where the value will remain the same, while still being able to spend and transfer it like any other cryptocurrency, therefore stable coins are the answer.
What is a stable coin there for?
1. Developing Markets
Stablecoins have the potential to help people living in countries suffering from high inflation rates, which, being a generally a result of economic and political uncertainty, reduces their purchasing power.
Living case in point — Venezuela, the citizens of which are facing hyperinflation on daily basis. Supposedly, it is one of the most burning problems in the country and, unfortunately, it is gaining momentum at a stable pace: Prices have been doubling every 26 days on average! That, obviously, affects the day-to-day lives of Venezuelans, the majority of which are trying to make ends meet. The annual inflation rate reached scaring 83,000% in July, according to the recent study of the opposition-controlled National Assembly.
It is extremely hard to move the capital elsewhere in countries like Venezuela due to capital control laws imposed by the government so as to prevent the money from leaving the country.
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The solution to resolve such devaluation of currencies may be quite simple — to convert the money in stablecoins, which will ensure the preserved value of the money, instead of keeping it in national fiat currency under the high risk of further reducing their purchasing power.
2. Hedging Mechanism for Traders
Nowadays, the crypto-currency exchange ecosystem is highly unfavorable towards a crypto-trader. The vast majority of existing exchanges are crypto-to-crypto (allow deposits in the form of cryptocurrencies only, not fiat), which brings to the conclusion that the best way to save the value of crypto is to reduce the volatility by hedging.
‘Hedge’ — basically means to reduce the risk of adverse price movements in an investment or an asset. Thus, a wide range of hedging strategies is often applied to protect your positions by reducing risks.
Stablecoins are commonly used for crypto-traders as a hedge against volatile cryptocurrency such as BTC/ETH (and other alt-coins). Traders sell their crypto for stablecoins if they consider the price of acquired cryptocurrency to be downward. This is a frequent example of effective protection from major BTC (bitcoin) declines and a valuable possibility even to earn on BTC volatility.
There are a number of stable coins in circulation today, each of them has a unique set of mechanisms, but they all generally work the same way: they pegged to something stable — fiat(dollar, euro, yen, yuan etc.), exchange-traded commodities (gold, silver, other industrial metal, etc.) or another cryptocurrency.
We will talk about each of stablecoin category in the next articles:
- Real asset backed stablecoins — https://medium.com/hyperquant/real-asset-backed-stablecoins-4c002ffa2bc8
- Crypto-collateralized stablecoins — https://medium.com/hyperquant/crypto-collateralized-stablecoins-129df769b089
- Seigniorage shares stablecoins — https://medium.com/hyperquant/non-collaterized-stablecoins-efc904b5e06a
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