How are Stablecoins affecting the crypto market?
Digital currencies have made global payments easier and more accessible. One of the notable options available is Stablecoins and it is making a big impact on the market.
Stablecoins are gaining popularity due to their spontaneous growth, increasing global use cases and possible volatile financial vulnerability flows. They are cryptocurrencies designed to be more stable than other crypto assets. Some are backed by the asset reserve to which they are linked, while some use algorithms to prevent rapid fluctuations in price values.
A stablecoin’s price depends on the price of the volatility of cryptoassets caused by negative cryptocurrency news and human emotions when you buy Bitcoin with credit card. This is in contrast to regular mining on an open, decentralized network of computers that complete a series of calculations and documentation. Its most basic function is to be a common denominator for volatile cryptocurrencies.
How do Stablecoins work?
Stablecoins are backed by a collection of assets that extend beyond crypto to certain fiat currencies and other influences. Examples of these fiat currencies and influences are the US dollar, rare metals and algorithms. Therefore, it can be safely suggested that the source of a cryptocurrency’s backing can affect its relative risk.
Stablecoins backed by a fiat currency can show more stability due to ties to a federal financial system with centralized government. Stablecoins that are backed by other cryptoassets can fluctuate rapidly over time. This is mostly due to the absence of a regulatory board that governs the cryptoassets each stablecoin is linked to.
Types of Stablecoin Support
Fiat-backed stablecoins are IOUs because you buy your stablecoins with your relative fiat currency, which can later be converted to the original foreign currency. Unlike other cryptocurrencies, the price value of fiat-backed stablecoins can only fluctuate minimally.
Other cryptocurrencies affect crypto-backed stablecoins. Since the underlying asset has a high volatility potential, stablecoins are backed by cryptos over collateral to reduce the risk of HODlers, improve the stablecoin’s trade rating and increase stability.
Stablecoins backed by precious metals rely solely on gold and other rare metals to maintain stability the cryptocurrency market valuation. These stablecoins are similar to Fiat stablecoins with their centralized features, although some crypto users consider this a disadvantage for certain reasons. However, the main goal of protecting the volatility of stablecoins is still appreciated.
Algorithmic stablecoins have no underlying assets. These stablecoins rely heavily on complex computer algorithms to maintain a stable value.
What value do they have in the market?
The market cap of all stablecoins is currently worth $151.66 billion, representing 15.91% of the entire crypto market cap. This makes them a smaller part of the cumulative crypto market. However, their popularity has increased due to more people invest in cryptocurrency.
They play a key role by creating a hedge against market volatility in Bitcoin (and other altcoins) while trading on exchange platforms. They also help when people store liquid assets in their crypto form. The basic roles of stablecoins are as follows:
- Stablecoins are globally decentralized cryptocurrencies that are created to offer price stability.
- They act as a bridge between cryptocurrencies and real-world assets such as gold, fiat, etc.
- Because of their relatively low transaction fees, stablecoins are preferred as a cheap medium of exchange.
- Stablecoins provide a lot of liquidity in Defi systems like DEXs and lending ecosystems. This is because they can be invested and used to earn interest over fixed investment periods.
- Stablecoins reduce common crypto volatility by holding safety reserves, often in the form of US dollars.
- Algorithmic stablecoins provide consistent value by modifying the supply in relation to current market demand based on predefined algorithms.
The Future of Stablecoins
While stablecoins already play some important roles in the crypto ecosystem, they still need a lot of improvements and regulations. This is to ensure that its current potential bugs are not exploited. For example, many stablecoins are minted on proof-of-work (PoW) consensus ecosystems. However, this method is relatively slower, less scalable and has high power consumption compared to networks using proof-of-stake (PoS) protocols.
PoS protocols increase transaction speeds by reducing validators and reducing the computational power required to verify each transaction. However, this can affect security, scalability and decentralization. The high amount of withdrawals induced by faster transaction speeds causes DEXs to limit withdrawal options for users. Yet this should not be; users from all over the world should be able to access their money at any time.
Furthermore, customer protection guidelines (such as confidentiality, cashback, surcharges and compensation for online fraud) do not currently apply to stablecoins.
Financial sustainability risk factors arising from Stablecoins
Stablecoins can present risks and vulnerabilities through different streams. Among these streams are:
- Counterparty risk
- Reserve risk
- Safety
Conclusion
Stablecoins offer a certain stability that most digital currencies struggle with. However, the cost and speed of stablecoin-related transactions and their recovery terms are below the practical medium of exchange requirements in many economies. Still, those who know how to buy cryptocurrency and own stablecoins should be aware of the risk. Although stablecoins appear to have few risks, this can quickly become the opposite if proper rules to enforce effective management of cryptoassets fail. Effective financial regulation for stablecoins is essential for risk-free innovation and stability.
