Cryptocurrency is a mainstream digital asset, and financial institutions and investors face new risk profiles. One way to mitigate these risks is to have stablecoins in the mix, as they offer a layer of certainty not found with cryptocurrencies. As a result, if you have been thinking of investing in bitcoin, now is the time to do so on a trading platform like this trading platform. However, it still needs to be determined how this new category of stablecoin will affect value chain relationships in the long term.
What Are Stablecoins?
Stablecoins, also known as “pegged currencies,” are cryptocurrency tokens whose value is tethered to another store of value—usually fiat currency—that is more stable and less volatile. The different types of cryptocurrencies available today have different monetary policies: Some use a fixed supply to control the inflation rate on their networks; others rely on supply and demand analysis (market-pegged).
In each case, these policies affect the token’s value, reducing or increasing it. However, these policies are only sometimes stable over time. The value of stablecoins can also fluctuate due to factors outside the control of a cryptocurrency’s design. For example, a new stablecoin may be created by people to fight Bitcoin’s volatility, which causes its price to rise and fall unpredictably.
Stablecoins Are Direct Copies of Fiat Currency
Stablecoins are currencies that consistently replicate fiat currency in their economic policy and structure. They are backed by fiat reserves, created and issued at a predetermined rate, and distributed by a governing authority.
Stablecoins can also be market-pegged or fiat-pegged. Market-pegged coins have their exchange rate pegged to the value of another cryptocurrency, such as Bitcoin. Fiat-pegged stablecoins are pegged to a local currency and maintained at 1:1. This means that when the value of their collateral is more than the stablecoins value, additional units are created; when it is less than that value, units are destroyed to maintain the 1:1 ratio. The main difference between these two types of stablecoins may be what happens with excess collateral.
Pros of using stablecoins over cryptocurrencies:
Stablecoins allow financial institutions to hedge against risks associated with cryptocurrencies. Storing fiat in stablecoins reduces the risk of volatility from cryptocurrency since it is not locked up in its value. Because stablecoins are backed by a fiat reserve and issued at a predetermined rate, they do not fluctuate based on market demand or supply. Instead, stablecoins are meant to preserve their value as they maintain a fiat-like policy.
This stability ensures that companies can invest with an established monetary policy to reduce exposure to volatility and price drops associated with cryptocurrency values.
Standardizing stablecoin policies opens opportunities for third-party suppliers of goods and services to engage customers directly through digital payment channels. In addition, since the policies behind stablecoins are not subject to the fluctuations of cryptocurrency markets, retailers, suppliers, and service providers can use stablecoins as a direct payment method.
For example, if a customer makes an online purchase with a standard cryptocurrency, there is no guarantee that the value will remain consistent throughout the transaction. In addition, it can create issues from a retailer’s perspective in which they are required to maintain banking relationships in multiple countries and comply with various global exchange rates.
3. Hedge against Failing Markets:
The stability of stablecoins allows customers to hedge against failing markets and assets. For example, if a bank were to face financial distress, the value of its stablecoin could be used as a form of capital to meet customers’ needs.
Due to the stability of stablecoins, they can be used by people in place of fiat currency when banks fail or in situations where banking relationships are unreliable or difficult to maintain across international borders.
4. Reducing Regulatory Risk:
The volatility and extreme price swings experienced by cryptocurrencies can make it difficult for financial institutions and government entities to comply with foreign regulatory frameworks and laws. It can result in penalties when institutions cannot accurately account for capital gains and losses.
Stablecoins offer an alternative to this issue by reducing regulatory risk. The stability of their value makes it easier for businesses to comply with various national and international laws. Stablecoin prices do not fluctuate as much as cryptocurrencies, making them more valuable as a store of value than Bitcoin or other digital assets. While fiat reserves back them, the stability of their value can also be measured by people against other assets like commodities, stocks, or bonds. It gives users more confidence that stablecoins will retain their purchasing power over time.
The Stablecoin Potential:
Using fiat currency as collateral allows stablecoins to be issued through fractional reserve banking, which makes it possible for institutions and businesses to create more units of value than they have in their reserves.
With cryptocurrency prices continuing to soar, the need to develop a platform that allows institutions and individuals to trade between fiat and digital assets has never been higher. The introduction of stablecoins offers an opportunity for financial organizations to develop solutions for digital asset trading without the volatility risks many organizations face with cryptocurrencies today.