The term stablecoin has become a household name in the crypto community. Tether (USDT), the first mover in the stablecoin market, currently has the 3rd largest market cap in the cryptocurrency market. And with the recent entrance of major players, like Paxos Standard, Circle, Dai, and a16z into the market, stablecoins seem poised to play a significant role in the crypto space.
A stablecoin is basically a digital currency meant to maintain a stable market value. Issuers achieve this stability by either backing the token with collateral in the form of traditional assets or mainstream cryptocurrencies or by designing algorithms that expand and contract the supply of the token in response to rising or falling prices.
Though a price-stable digital asset intuitively sounds interesting, it is good to weigh what these projects might accomplish if they are successful in the long run. In other words, what are stablecoins actually for? In today’s article, we will briefly study four main use cases for stablecoins.
A haven for investors
During the crypto boom of 2017, the most popular group of investors in the cryptocurrency market was retail investors. They purchased bitcoin as an investment vehicle and drove the 2017 market to great heights. While institutional investors and high net-worth investors are beginning to play a bigger role in the market, retail investors still occupy a significant role.
The primary goal of any investor is to make profits from their investments. And not just paper gains- they want to convert their paper profits into money that can be held, spent, or reinvested. To achieve this, investors initially had to convert their holdings back into fiat money. Otherwise, there are stuck leaving their profits further exposed to high volatility of the major investment cryptocurrencies, such as bitcoin and Ether, where their profits could be wiped out virtually overnight.
There are two main issues with the above situation. First, it is extremely inefficient since transferring wealth between crypto and fiat can sometimes take days, add extra costs, and most require the involvement of a third party, like a bank. Secondly, this system brings a near regular need to transfer wealth back and forth as investors enter and exit positions on the market.
Stablecoins can solve these issues by creating an on-chain asset safe from market volatility. Traders who want to withdraw gains, or exit a bad position can simply swap their holdings with stablecoins without leaving the blockchain.
Transferring money around the crypto ecosystem
Cryptocurrency exchanges are not the only platforms where digital assets are needed. As the industry grows, there will likely be an increasing demand to use crypto for purposes beyond just exchange and trading like paying for dApp services.
In this regard, market volatility could be a major problem than it is for investors. Traders expect the price of cryptocurrencies to increase and decrease and can prepare for this by hedging their portfolios. Other use cases, like decentralized newsrooms, games, and social media platforms will require a stable unit of account. Stablecoins will offer a solution by acting as a stable unit of account in crypto-denominated terms.
The dream of most crypto believers is for cryptocurrencies to one day be used for daily purchases of goods and services. The dream is still far off, but it is worth noting that stablecoins are an important step forward. For our economies to run effectively, we need a stable unit of account for paying for goods and services. Stablecoins fit this role well since they maintain a stable value.
Stability for everyone
Finally, stablecoins can be used to expand access to reliable fiat currencies. People from developed countries are used to having a national currency that they can trust to stay relatively stable and act as a safe store of value for their wealth.
Sadly, this is not the case in other countries, where people are somehow helpless in the face of bad economic policies that lead to inflation. In 2018, Turkey saw the value of the Lira inflate drastically. In reaction, bitcoin trading in Turkey increased greatly. Nevertheless, turning to bitcoin solved the situation halfway since bitcoin is also highly volatile.
Stablecoins can offer a more stable alternative for citizens of countries with bad economic policies. It may be a difficulty for individuals living in these nations to access and hold US dollars, but with a smartphone and an internet connection, they can invest in USD-pegged stabelcoins, like USDT.
None of the existing models are perfect: fiat-backed tokens are mostly centralized, crypto-backed tokens are still exposed to volatility, and also asset-backed tokens often rely on never-ending platform growth. As additional models emerge and new projects develop, developers may invent use cases we have not even thought of yet.
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