Cryptocurrency
How is a stablecoin paired with a fiat currency?
Stablecoins were born with a very attractive proposition for those investors who see the volatility of the cryptocurrency market as a problem more than a solution for their financial reserves and for their investments.
Because of this concern about market instability, stablecoins were launched. They are, in short, digital currencies paired with a fiat currency such as the dollar or the euro.
What seemed to be a very dangerous mix between the real and the digital, however, was very successful. This has caused different global economies to modify their currency structures to also launch their own currencies into a virtual asset format.
Among these world economies we also have Brazil. Brazil is expected to launch its own version of the real in the digital world by 2024, a project that was called the digital real, and which is still surrounded by a lot of speculation.
Now, we invite you: do you want to know everything about stablecoins and how they remain unharmed by the movements of the digital asset market? Follow now another exclusive article from CriptoFácil!
What is a stablecoin?
A stablecoin is a type of cryptocurrency that uses a methodology to fix its value always 1:1 with a specific fiat currency – in most cases, but we will see later –, which is issued by a government or even a Central Bank. .
In this way, they are cryptocurrencies that are, from their inception, designed to maintain their stability according to the value of a hard currency, a fiat currency, therefore.
But, at the same time, because it is a cryptocurrency, we have all the security, speed and, above all, the minimum fees for transactions. All this is done in order to favor the investments of people looking for more stability in their applications.
Stablecoins were created as a way to minimize the impact of cryptocurrency price volatility and to be a bridge between digital and real, both to fund our day-to-day expenses and to be a link between financial institutions.
However, now stablecoins seem to have found an even more interesting path, branching out into the banking sector as well as a way to reduce costs, as well as charges, when making payments.
So far, we have four types of stablecoins on the market, either centralized or decentralized.
Centralized stablecoin-type cryptocurrencies can be backed by fiat currencies such as the dollar or euro, commodities, or even other cryptocurrencies.
Decentralized stablecoin is supported by algorithms and smart contracts so that its value can be maintained automatically.
What is a fiat-backed stablecoin?
The fiat-backed stablecoins can be understood as the simplest model of this type of asset.
They are paired one-to-one in different fiat currencies, such as the dollar or euro, but there are already initiatives for yen, for example.
As long as the reference currency remains stable, the stable cryptocurrency will also remain stable. Thus, they are backed by a criterion of faith and total credit of the person issuing the reference currency, which has a value determined by the country’s central bank.
To issue a stablecoin, a company needs to purchase fiat currencies, such as the dollar or euro, and store them in bank accounts of trusted institutions.
In this way, it is only possible to issue a stablecoin if it is properly backed by the fiat currency with which it is paired.
The biggest risk related to this type of stablecoin concerns when it is not properly backed, having an issuance greater than what it actually has in its reserves.
What is an asset-backed stablecoin?
In turn, commodity-backed stablecoins end up replacing fiat currencies with another variety of assets, which have tangible guarantees and which are most commonly backed by the gold reserve of value.
Other cryptocurrencies can be backed by precious metals and currently even in real estate we already have stablecoins being issued.
Generally speaking, all these stablecoins are tied to a certain amount of the commodity, which is issued and stored in a location that is known and also frequently audited.
Other cryptocurrencies can be backed by barrels of oil, gemstones and other goods that can be easily indexed to their value in a simple way.
This stablecoin category is different, however, from the previous one, because of its volatility. This is because its value is directly indexed to the price of a raw material on the market.
What is an algorithmic stablecoin?
Algorithmic stablecoins are certainly the most complex version of a stable cryptocurrency, mainly because they are not backed by either a fiat currency or an asset like gold, precious metal, Swiss real estate or a barrel of oil.
Unlike other cryptocurrencies that are backed by coins or items of commercial value, this type of stablecoin is backed only by smart contracts and algorithms.
Tokens that are in circulation, in general, can be issued or even burned, according to the variation in the price of the asset, always looking for a certain stability.
In practice, this algorithmic system is responsible for reducing the issuance of assets whenever the price of the stablecoin falls below the value of the fiat currency to which it is indexed.
What is a cryptocurrency-backed stablecoin?
This type of stablecoin is called crypto-collateralized in the market and caters to a group of investors looking for crypto-assets that are backed by either a basket of one or more cryptocurrencies.
When it comes to this type of stablecoin, we always have to take into account that the values of its quote are modified as the value of the cryptocurrency to which the stablecoin is indexed varies.
As cryptocurrencies are highly volatile, this type of asset also ends up being highly overcollateralized, thus requiring its buyers to leave their tokens locked up as collateral, through smart contracts.
These smart contracts, in turn, cause the amounts to settle if the value of the blocked escrow deposit falls below the value determined in the contract. This collateral can then be collected instead of the stablecoin.
What is a stablecoin for?
A stablecoin is an excellent option for all those looking to have greater exposure to the dollar or any other fiat currency, but without having to expose themselves to volatility and strong price fluctuation, which is characteristic among cryptos.
In this way, a stablecoin serves to provide greater liquidity to your wallet, being possible to use it in exchange for the fiat currency to which it is indexed, having a high acceptance.
It can also be used to make different international remittances, but without the need to pay any additional fees to the exchange house, for example, or to any other type of intermediary, such as banks, for example.
Finally, stablecoin can also be used as a way to protect an investor’s equity against market volatility.
Is it possible to use a stablecoin in everyday life?
Using a stablecoin on a day-to-day basis can be a reality as long as there is a preliminary agreement between the parties, payer and recipient.
In addition to using stablecoin as a form of payment, it is also possible to use it as a way to invest in a hard currency, a fiat, or a fiat currency, thus protecting the investor’s assets.
Another way to use this resource on a day-to-day basis is to use it as a way of optimizing idle balances in your portfolio, protecting your assets and making it obtain important returns for your portfolio.
Finally, another way to use this type of asset on a daily basis is to send international remittances through stablecoin. This allows you to optimize your shipments, without paying additional fees to the broker or the bank responsible for the shipment.
What are the disadvantages of investing in a stablecoin?
The main disadvantages in relation to investments in a stablecoin relate, above all, to the fact that this type of asset does not have the potential for appreciation or even the profitability of a conventional cryptocurrency, such as Bitcoin.
In this type of investment, another point that draws a lot of attention is the fact that there are simply no concrete guarantees that the issuer has, in fact, backed the asset’s deposits.
Another point that can also be seen as a disadvantage is that converting the stablecoin to the fiat currency to which it is pegged can be a headache for the investor, having to be quite restricted to investment funds, for example.
What are CBDCs?
The CBDC is the so-called Central Bank Digital Currency, that is, a digital currency that is issued directly by governments or even central banks. That is, despite being a digital currency, we are still talking about a fiat currency – as will the digital real.
In this type of investment, it is the issuer itself that determines the rules for using the new cryptocurrency and what the format for issuing these cryptos will be.
These coins do not necessarily rely on a blockchain – which would be the public ledger of these cryptocurrencies. They may use a distributed record only for their minting and then issuing.
In relation to this type of investment, the common user does not have any power, as they can have their transactions modified according to the cryptocurrency issuer’s policies, while in traditional stablecoins all the rules are explicit.
Is it safe and worth investing in stablecoins?
When it comes to the security of a user in relation to a certain type of investment, we must always insist that this feeling of security is linked to the style of each investor, in particular.
Therefore, we cannot assume that an asset is safe just because it is pegged to a fiat currency that may already be part of our traditional investments.
All types of investment, after all, represent some risk for those who make them, whether they are of greater capillarity or not.
Thus, before any investment, it is always very important to analyze not only your investor profile, but also what are your ambitions in relation to the money invested there, what are your goals or even dreams in relation to it.
Given these points, it is possible to measure more adequately whether an investment is suitable for your profile, always analyzing the level of risk to which you are exposing yourself – and also exposing your dreams, personal projects and plans.
In this way, it is possible to have a higher rate of success in relation to the type of investment made, improving, above all, its levels of profitability.
In conclusion…
A stablecoin is a type of digital asset, a cryptocurrency, that must remain paired with its fiat currency of reference, always maintaining a one-to-one relationship with the currency issued by a government or a central bank.
In this way, we are dealing with a fully digital asset, which is minted within a blockchain or a government system, which shares real-time data regarding its appreciation rates and its actual value.
The advantage of this type of asset is that it will always be paired with the value of a fiat currency, such as the dollar or the euro, for example. A major downside, however, is that this currency will always appreciate less than others, such as Bitcoin.
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