Stablecoins Explained
In the world of cryptocurrency, stablecoins offer a bridge between the volatile nature of digital currencies and the stability of traditional money. Stablecoins are a type of cryptocurrency that is pegged to real-world assets, such as national currencies like the US dollar, Euro, or British Pound. This concept of “pegging” means that the value of a stablecoin is tied to a specific asset, helping it maintain a consistent value, unlike other cryptocurrencies that can fluctuate wildly.
Think of a stablecoin as a digital currency in your digital wallet, the equivalent to traditional bucks, euros or quids in your pocket or traditional physical wallet.
Just like you might buy stocks or shares with traditional, also known as fiat currency, you can buy cryptocurrency like Ethereum, BitCoin or Solana with stablecoins. The crypto and stablecoin combination is known as a pair, you might see it written as BTC/USDC, ETH/EURS, SOL/BRITCOIN or typically GBPT etc. These for beginners are the simplest to understand pairings, there can be many pairings that you will see on exchanges not always linked to a stablecoin, e.g. BTC/ETH. For the purpose of this post we will keep it simple with the easier to understand stablecoin pairs.
What Is Pegged?
A stablecoin is a digital currency designed to maintain a stable value by being backed by or “pegged” to assets like traditional currencies (also known as fiat currencies), commodities, or other assets. For example, stablecoins can be tied to the US dollar (USD), Euro (EUR), or British Pound (GBP). This means that for every unit of a stablecoin issued, an equivalent amount in US dollars, euros, pounds or other assets is held in reserve. The funds held in reserve are typically not held by a bank, yet. The Bank of England are showing interest in this with their Britcoin but other pegged stablecoins are funded by institutions who are audited to to ensure stability with their stablecoins. This is why you may see variants of stablecoins, especially USD where the are a number, the most popular being USDT (Tether) and USDC (Circle) etc.
This stability is achieved because stablecoins are backed by tangible assets. In other words, for every stablecoin in circulation, there is (or should be) actual value stored somewhere, such as in bank accounts, government bonds, or other financial instruments.
This is particularly interesting for gold backed crypto. Yes you can buy gold pegged to actual physical gold. Just like fiat stablecoins which require the same amount in reserve as the coins available, gold backed crypto has the equivalent amount of gold. With gold seeing popularity recently with investors and in 2024 seeing record high prices, it makes sense to buy digitised gold – saves keeping it under your bed. More on gold in future posts but if you are interested have a look at XAUT (Tether), who store their gold in a vault in a Swiss mountain and if you buy enough XAUT you can actually get your physical gold if you wish. Or PAXG who store their gold in high-security London vaults managed by Brinks. I digress …
Key Uses of Stablecoins
Stablecoins offer several practical uses in the cryptocurrency ecosystem:
1. Reducing Volatility: In comparison to cryptocurrencies like Bitcoin or Ethereum, which can experience drastic price changes, stablecoins maintain a steady value. This makes them appealing for users who want to avoid market volatility.
2. Facilitating Trade: Stablecoins are commonly used for trading on crypto exchanges. By holding stablecoins, traders can quickly enter or exit positions in volatile markets without converting back to fiat currencies.
3. Cross-border Payments: Stablecoins are often used for international transactions, offering a faster and cheaper alternative to traditional banking systems. Because stablecoins are tied to widely accepted currencies like the US dollar, euro, or British pound, they provide stability and familiarity for global transactions.
4. DeFi and Lending: Stablecoins are also an integral part of decentralised finance (DeFi), where they are used in lending, borrowing, and earning interest in a secure and predictable manner.
What Does “Pegged” Mean?
When we say a stablecoin is “pegged” to a currency, it means the value of the stablecoin is tied to that currency. For example, USDC (USD Coin) and USDT (Tether) are both pegged to the US dollar. This means that 1 USDC or 1 USDT is meant to always be worth 1 US dollar.
Similarly, there are stablecoins pegged to other fiat currencies, such as the euro and British pound. EURT (Euro Tether) is pegged to the euro, meaning 1 EURT is intended to be worth 1 euro. Likewise, there is GBPT (British Pound Tether), which is pegged to the British pound. These stablecoins function similarly to their USD counterparts, with reserves held in euros or British pounds to maintain stability.
How Are Stablecoins Funded?
The backing of stablecoins is provided by institutions that hold assets such as cash or government bonds in reserves. For example, USDC is issued by Circle and Coinbase and is backed by actual US dollars and other highly liquid assets. USDT, created by Tether, operates similarly, although there has been some debate over the exact composition of its reserves.
In addition to US dollar-backed stablecoins, Tether also offers EURT (Euro Tether), which is pegged to the euro, and GBPT (British Pound Tether), which is pegged to the British pound. These stablecoins are backed by reserves held in their respective currencies or highly liquid assets that match the value of the currency they are pegged to. Another euro-backed stablecoin is Stasis EURS, which is fully backed by euro reserves and regularly audited.
Recently, large companies like PayPal have entered the stablecoin market. PayPal’s stablecoin, PYUSD, is also pegged to the US dollar and is fully backed by US dollar deposits, short-term US Treasury bonds, and other cash equivalents. This is a notable development as it signals the entry of major financial players into the cryptocurrency space, lending more credibility to stablecoins.
Why Use Stablecoins?
There are several reasons why someone might choose to use stablecoins:
•Ease of Use in Crypto Transactions: Stablecoins make it easier to transact in the crypto space without worrying about price fluctuations.
•Liquidity: Stablecoins can be quickly converted into other cryptocurrencies or fiat money, providing flexibility for traders and investors.
•Financial Inclusion: In countries with unstable national currencies, stablecoins can offer a more reliable store of value and a way to access global markets.
•Safe Haven in Volatile Markets: During periods of high market volatility, users can hold stablecoins to protect the value of their assets without needing to withdraw into traditional currencies.
Examples of Stablecoins
1. USDC (USD Coin): Issued by Circle and Coinbase, USDC is one of the most trusted stablecoins, fully backed by US dollars and liquid assets. It is used widely across crypto exchanges and DeFi platforms.
2. USDT (Tether): Tether is one of the earliest stablecoins and is widely used for trading. It has faced scrutiny in the past over its reserves but remains one of the most popular stablecoins.
3. PYUSD (PayPal USD): PayPal’s entry into the stablecoin market, PYUSD is fully backed by US dollars and US Treasuries. It provides a familiar option for users in the PayPal ecosystem to interact with digital currencies.
4. EURT (Euro Tether): Similar to USDT, EURT is pegged to the euro, with reserves held in euros or euro-denominated assets. This makes it a useful stablecoin for euro-based transactions and trading.
5. GBPT (British Pound Tether): GBPT is a stablecoin pegged to the British pound, making it useful for those who trade or transact in GBP. It is backed by British pound reserves, ensuring its value remains stable.
6. Stasis EURS: EURS is another euro-backed stablecoin, fully backed by euros and regularly audited to ensure transparency. It is commonly used in the European crypto market.
Conclusion
Stablecoins provide an essential layer of stability in the often unpredictable world of cryptocurrencies. By being pegged to traditional currencies such as the US dollar, Euro, or British pound, and backed by real-world assets, they offer the benefits of crypto while minimising the risks associated with volatility.
Understanding stablecoins is a basic fundemental for anyone starting in crypto and provides an easy to understand and familiar way to start in digital currency.
Whether you’re looking to trade, make cross-border payments, or simply hold your assets securely, stablecoins offer a practical and reliable solution.
Leave a Reply