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SFM Labs - Stablecoins

Updated: Jun 10, 2022

A quick disclaimer upfront: all information given in this presentation is researched and intended to be educational and illustrative to the specific topic as always. Any companies, products, people, or other items mentioned do not constitute an endorsement, recommendation, or relationship. Every owner has to do their due diligence, as the decisions and responsibility about any investment lie with the owner. This is no financial advice.

What is a stablecoin?

A stablecoin is a digital currency that is pegged to a reserve in the world. This can be a monetary currency such as the US dollar or the Japanese yen, or a resource such as gold, platinum or oil.

Definition of a stablecoins

Stablecoins allow cryptocurrencies to be traded at constant, stable currencies, which serve as a basic means for payment exchanges. The trader does not have to leave the platform and can sell his currency on the respective marketplace and convert it into stablecoins, but instead of exchanging them directly into fiat currency. Stablecoins are therefore primarily a direct means of exchange between fiat currency and cryptocurrency.

Why do we need stablecoins?

Stablecoins are important for trading cryptocurrencies and regulating the flow of money within the respective crypto platforms. Without them, a simple exchange of real currencies into virtual ones would not be possible, but it serves other purposes here as well:

1. Reducing volatility

Coupling a stable currency to a volatile cryptocurrency not only makes the price of the volatile cryptocurrency more stable, it also provides the security that the otherwise uncoupled values are not free from any price development and can therefore experience a free fall.

2. Exchange commodity for other currencies

A stablecoin can serve as a trading commodity for other currencies, for example, if a currency is not available in a certain country or is difficult to trade and involves many fees. For example, instead of the exchange rate and the loss of value, the stablecoin can be traded.

3. Interest

Stablecoin can be suitable for the long-term, because the value of the stablecoin typically does not change, while the interest rate can be significantly higher compared to regular banks.

4. Low transaction fees

Paying bills, sending monetary gifts or even simply exchanging currencies can be expensive in some circumstances. With stablecoins, the transaction fee can be very low as there are often no significant middle men or bank fees except for the certain fees charged by trading platforms.

5. Global trading

Compared to restrictions on certain currencies in countries, trading is generally possible everywhere. A trading partner only needs a wallet, which they can use to receive or send the currency (if not directly regulated by an exchange).

Different types of stablecoins

There are mainly three different types of stablecoins that need to be distinguished:

1. Stablecoins pegged to fiat

These stablecoins contain a reserve in fiat currency, which is intended to serve as a counterbalance to price fluctuations and to create stability. The best example here is the U.S. dollar, which is used in the direct use of Tether (USDT) and cushions the parity in the currency fluctuations by large stockpiling of dollar currency.

2. Stablecoins pegged to crypto

Stablecoins can also be directly pegged to cryptocurrencies. In this case, it is important that a double, secure stability prevails, so that a fluctuation does not destroy both projects of the coupling. As an example, there are DAOs that are tied to the US dollar, but they are also strengthened by ETH in a branch coupling and thus cushions the stablecoin against changes in the US dollar with the help of the cryptocurrency.

3. Algorithmic stablecoins

In the case of algorithmic stablecoins, the original principle of a coupling is not given. This type of stablecoin tries to regulate the value of its currency on the basis of its created and circulating quantity, in order to compare, weight and maintain the steady demand and stock on the basis of a constant in equal proportion by means of algorithms. This can be done with the help of the US dollar as equilibrium, but most algorithms here are one-dimensional and act only within their own stablecoin currency.

Advantages and risks of stablecoins

Stablecoins can offer advantages to the general market such as global availability, lower fees and ease of use. The typical sense of a stablecoin - the perpetual, stable provision of a currency - is not only in the field of normal trading a super alternative, but can also offer in the long term a good variation through interest and uniform structure.

However, it can also bring the risk of safety, which is the biggest problem for stablecoins. Safety try to be given at all times to prevent manipulation and robbery. Because the reserves of stablecoins are enormous, security gaps can not only lead to huge problems, but also to the potential destruction of crypto investments. Therefore, it is important that a stablecoin, which is widely used, is constantly and permanently checked for its safety.

Future development of stablecoins

Stablecoins are effectively seen as the basis of all trading and mixing between fiat currency and cryptocurrency. They are essential for basic trading and provision of funds and play a major role in stabilizing systems. This is not only known by the respective trading venues, but also noticed by any regulators. Therefore, the future may likely be about the regulation of cryptocurrencies as well as the regulation of stablecoins, because the fees charged, the venues used, and the availability mean a lot of money that is traded and that neither financial systems, governments, or countries earn from. Therefore, in the future, the financial structure of stablecoins will remain, but will probably be further adapted or even replaced by stablecoins of the respective financial sectors of the world.



Gandalf - SafeMoon Educator

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