Stable Coins: stability in the world of digital assets

The cryptocurrency market is known for its unpredictability. Prices for Bitcoin (BTC), Ethereum (ETH), and altcoins can fluctuate by tens of percent within hours. This is why a solution emerged — stablecoin, a digital asset specifically designed to maintain a constant value by being pegged to a specific asset.

Why Stablecoins are Needed: Solving the Volatility Problem

At first glance, it may seem odd: why do we need a cryptocurrency that does not appreciate in value? The answer is simple — stablecoins address a key problem of traditional cryptocurrency. Imagine a coffee shop that accepts BTC. On Monday, a customer pays for coffee with bitcoins worth $5. By Wednesday, the received tokens lose half of their value. This situation makes it impossible to use cryptocurrencies in everyday life and complicates financial planning.

Stablecoins solve this dilemma. They can be pegged to the US dollar, euro, pound sterling, or even precious metals — gold and oil. Investors and traders gain the opportunity:

• Lock in profits without converting funds to traditional currencies
• Quickly transfer assets between positions on compatible blockchain networks
• Avoid the influence of market volatility on the portfolio

Three Stablecoin Architectures: How They Maintain Stability

There are three main approaches to creating a stablecoin, each of which uses a different pegging mechanism.

Fiat-backed model

This type of stablecoin is the simplest and most straightforward. The issuer holds real money (dollars, euros, or pounds) in reserves and issues tokens according to this collateral. For example, for every token TrueUSD (TUSD), there is exactly one US dollar in reserve.

The advantage of such a model is the transparency of the mechanism. The user can exchange the stablecoin for fiat currency at a fixed rate at any time.

The drawback is centralization. Reserves are held by a single organization that may be subject to financial regulation. The user has to trust the issuer that its reserves actually exist and are fully backed.

Cryptographic Assurance: Redundancy as Insurance

Crypto-backed stablecoins function differently. Instead of traditional currencies being used as collateral, the cryptocurrencies themselves — Bitcoin, Ethereum, and others — are used. However, due to the volatility of the crypto market, such projects apply excessive collateral.

Let's consider a real example - DAI from MakerDAO. To create 100 stablecoins DAI, pegged to the dollar, you need to deposit cryptocurrency worth $150. This over-collateralization protects the system from price fluctuations.

When the price of DAI falls below $1, holders are incentivized to return tokens in exchange for collateral. This reduces supply, and the price recovers. If DAI rises above $1, users are motivated to create new tokens, increasing supply and lowering price. This mechanism is managed by smart contracts on Ethereum, which can be independently audited.

DAI is governed by the MakerDAO community through voting by MKR token holders. This is a decentralized approach, but it requires active participation or at least trust in the decisions being made.

Algorithmic stablecoins: a reserve-free method

The third option is the most experimental. Algorithmic stablecoins do not hold any reserves at all. Instead, special algorithms and smart contracts automatically manage the amount of tokens issued.

If the price drops, the system reduces the supply through staking, burning, or buybacks. If the price rises, new tokens are introduced into circulation, which should lower the cost. This relies on game theory and network incentives.

This model is encountered less frequently and is more difficult to manage. The risk of losing the peg is higher here, but it is potentially more decentralized.

Advantages: why stablecoins have conquered the market

Stablecoins have become an indispensable tool for traders, investors, and regular users. Here are the main advantages:

Applicability in real life. Companies and individuals need stability. If a large stablecoin maintains its peg, it can be used for daily payments, unlike volatile BTC.

Blockchain Mobility. The token can be sent to any point in the world to a compatible crypto wallet in just a few seconds. This eliminates the risks of double spending and fraudulent transactions. This opens up opportunities for international transfers with low fees.

Portfolio hedging tool. Traders allocate a portion of their portfolio to stablecoins to reduce overall risk. This approach preserves funds for a successful purchase during a market downturn. One can sell cryptocurrency for stablecoins during a decline and buy back at a lower price — this is called shorting.

Trading convenience. Stablecoins allow for quick entry and exit from positions without converting funds back to fiat, saving time and fees.

Risks and Limitations: What You Need to Know

Despite their usefulness, stablecoins have serious drawbacks that cannot be ignored.

The peg can break. Although major projects maintain their value, many fail. If a stablecoin loses its connection to an asset, its value can plummet. History knows examples of projects that lost their reserves, faced lawsuits, or simply went bankrupt.

Lack of transparency. Not all issuers publish complete independent audits. Most are limited to regular attestations from private accountants. This does not guarantee honesty and the presence of declared reserves.

Centralization of fiat stablecoins. Those backed by dollars are usually more centralized than other crypto assets. The collateral is held by a single organization, which may be subject to government regulation and oversight.

Dependence on the community. Crypto-backed and algorithmic stablecoins rely on community governance. Users must either actively participate in voting or trust the decisions of other participants. An incorrect decision can lead to the loss of funds.

Real-world use cases

TrueUSD (TUSD) — an independent verifiable stablecoin pegged to the dollar. It was the first project that programmatically manages mining with instant verification of USD reserves held off-chain. TUSD reserves are verified through the Proof of Reserves (PoR) mechanism of the Chainlink network, allowing users to independently verify that their assets are fully backed.

DAI from MakerDAO is one of the most popular crypto-collateralized stablecoins pegged to USD on the Ethereum network. It is governed by members of the MakerDAO community through MKR token voting. It uses over-collateralization and smart contracts to manage collateral. This is a decentralized alternative to fiat stablecoins.

Regulation: new attention from the government

Stablecoins are attracting the attention of regulators worldwide. The reason is simple — they connect the traditional financial system with cryptocurrencies. Due to their stable price, stablecoins can be used not only for speculation but also for everyday payments and international transactions.

Some countries are even developing their own stablecoins. For the most part, legislation treats stablecoins as cryptocurrencies and applies existing rules to them. The issuance of stablecoins backed by fiat currency often requires approval from financial regulatory authorities.

Conclusion: an indispensable but caution-required tool

Today, it is difficult to find a trader or investor who does not hold stablecoins. They are stored on crypto exchanges for quick market opportunity searches, used for opening and closing positions, as well as for payments and transfers.

Stablecoins have become a critically important part of the crypto ecosystem and have laid the foundation for a new financial architecture. However, their risks are real — loss of peg, depletion of reserves, lawsuits, and other issues can lead to losses.

Remember: a stablecoin is still a cryptocurrency with its risks. Diversify your portfolio, conduct thorough research before any transaction, and never invest more than you can afford to lose.

Important Warning: This information is provided for educational purposes only. It is not financial, legal, or investment advice. Digital assets are volatile, and their value can rise or fall. You bear full responsibility for your investment decisions. Please consult with qualified professionals before making any decisions.