Stablecoins were introduced as an alternative to regular cryptocurrency because of how volatile regular crypto tokens are. In the last few years, their popularity has greatly increased and it has gained a lot of recognition in the market. As a novice crypto trader, it is easy to mix up the meaning of stablecoins and regular cryptocurrencies. However, both of these digital assets are very different from each other. This article highlights the meaning of stablecoins, how stablecoins work, the types of stablecoins, as well as other important factors of this kind of digital asset.
What are stablecoins?
Stablecoins are cryptocurrencies that have a value that is pegged, bound, or tied to another currency, financial instrument, or commodity. Essentially, this kind of cryptocurrency aims to provide traders with an alternative to regular cryptocurrencies since they had high volatility. The high volatility of regular cryptocurrencies, such as Bitcoin (BTC) and Ethereum (ETH) has made crypto investments less convenient for everyday transactions.
Why are stablecoins so important?
Stablecoins are important because they don’t suffer from high volatility in price, unlike regular cryptocurrencies. Hence, they provide traders with a more stable and safer investment alternative.
Popular cryptocurrencies like Bitcoin tend to experience high volatility in their exchange rate and price, which makes them very unstable. For instance, the price of Bitcoin increased from under $5,000 in March 2020 to more than $63,000 in April 2021. Unfortunately, the price plunged to nearly 50% over the subsequent two months. Also, intraday swings can get very wild, as Bitcoin often moves over 10% within just a few hours.
Although volatility can come in handy for traders, it makes regular trading transactions become risky for both buyers and sellers.
To serve as a valid medium of exchange, currencies that are not legal tenders must remain moderately stable, guaranteeing people who buy them that they will maintain purchasing power over the short term.
Stablecoin’s goal is to address this price fluctuation problem by pledging to retain the value of the cryptocurrency steady in numerous ways.
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What is the purpose of stablecoin?
Stablecoins’ purpose is to offer a more suitable alternative to the very high volatility of prevalent cryptocurrencies, such as Bitcoin (BTC). Volatility can make cryptocurrency less convenient for common transactions.
How does stablecoin work?
So here’s how stablecoins work. Stablecoins try to peg their general market value to an external reference, typically a fiat currency. Generally, they are far more valuable than popular volatile cryptocurrencies as an actual medium of exchange. Stablecoins can be tied to a stable currency like the U.S. dollar or be pegged to the cost of a precious commodity, like gold. An algorithm can also be used to control supply. Also, they retain reserve assets as their collateral or via algorithmic formulas that are meant to control their supply.
Note that a crypto’s backing source may affect the risk level of stablecoins. For instance, a fiat-backed stablecoin may generally be far more stable since it is tied to a centralized financial system, which provides it with a respected authority figure (such as a central bank). This authority figure can step in and regulate prices whenever valuations are very volatile. However, stablecoins that aren’t tied to any centralized financial systems, such as a bitcoin-supported stablecoin, may switch drastically and rapidly in part since there is no governing body that is maintaining what the stablecoin is tied to.
What kinds of stablecoins are there?
There are basically four different types of stablecoins. They are categorized based on the different mechanisms used for stabilizing their value. Here is a list of the different kinds of stablecoins:
1. Crypto-collateralized stablecoins
These kinds of stablecoins are supported by other cryptocurrencies. Since the reserve cryptocurrency can also be liable to high volatility, these stablecoins are overcollateralized. Essentially, this means that the value of the cryptocurrency kept in reserves surpasses the real value of the stablecoins disseminated.
A cryptocurrency worth $3 million may be kept as a reserve to issue just $2 million in a crypto-supported stablecoin. This helps to insure against a 50% decrease in the real price of the cryptocurrency held in the reserve. For instance, MakerDAO’s Dai (DAI) stablecoin is tied to the U.S. dollar, however, it is supported by Ethereum (ETH) and every other cryptocurrency that is valued at 150% of the DAI stablecoin currently in circulation.
2. Fiat-collateralized stablecoins
Fiat-collateralized stablecoins retain a secure reserve of one or more fiat currencies like the U.S. dollar. This reserve serves as collateral and guarantees the stablecoin’s value. Other kinds of collateral may include precious metals such as gold or silver as well as valuable commodities such as crude oil. Nevertheless, most fiat-collateralized stablecoins possess reserves of a fiat currency like U.S. dollars.
Their reserves are sustained and audited by independent custodians. Examples of popular stablecoins backed by U.S. dollar reserves include Tether (USDT) and TrueUSD (TUSD).
3. Algorithmic stablecoins
Algorithmic stablecoins are unique kinds that may or may not possess reserve assets. Essentially, their primary difference is the technique of retaining the stablecoin’s value by regulating its supply via an algorithm. This algorithm is primarily a computer program operating with a preset formula.
In some ways, they work like Central Banks, which also don’t depend on any reserve asset to hold the value of any currency they issue as stable. The only difference is that Central Banks establish monetary policy for the public, which is based on moderate and well-understood parameters. Also, its status as the legal tender issuer works wonders for the dependability of that policy.
Unfortunately, algorithmic stablecoin issuers will not be able to fall back on this benefit during a crisis.
4. Precious metal-backed stablecoins
Precious metal-backed stablecoins primarily use gold or any other precious metal to help retain their value. Essentially, these stablecoins are centralized, and although traders see this as a disadvantage, it can safeguard them from crypto-high volatility. For a long time, Gold has been seen as a barrier against volatility in the stock market and general inflation, which makes it a great addition to portfolios in highly fluctuating markets. Digix is a popular stablecoin supported by gold that provides investors with the capacity to invest freely in precious metals without encountering any difficulty in transporting and storing them.
Why do people use stablecoins?
The major reason people are interested in stablecoins is that they are generally built to resist volatility in a strong way that other popular cryptocurrencies aren’t. Nevertheless, they still offer traders mobility and accessibility.
Although stablecoins may not be the well-talked-about investment that other regular cryptos are, people still use them because they offer stability against volatility. They are inherently created to keep their general prices stable, not shoot up in value.
Also, some kinds of stablecoins may be used for cryptocurrency staking, in which owners can gain rewards by practically lending out their crypto possessions to help perform other transactions. Note that staking carries risks, so you must fully understand the coin you want to use before you stake it.
Where can I buy stablecoins?
To purchase stablecoins you’ll need to have an account with any digital wallet or crypto exchange where you can purchase crypto directly. Note that some services may be restricted to you depending on your location so ensure you check if the option you want is available in your location first.
Popular exchanges like Bitmama may offer an array of stablecoins to choose from including USDT, USDC, cUSD, and more.
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How to buy stablecoins on Bitmama
You can purchase stablecoins on Bitmama either through instant order or via our P2P marketplace.
Purchasing stablecoins directly from Bitmama (Instant order)
Follow the steps below to purchase stablecoins directly from Bitmama:
1. Download the Bitmama app for Android or iOS, register and log in.
2. Navigate to the verification page in your ”Account” section. Click on the verification button to submit the necessary documents and verify your account up to level 3.
3. Fund your Bitmama wallet with the sum you wish to purchase your preferred stable coin by selecting “Fund” on the homepage and following the process.
4. Return to the homepage and, select “Buy”.
5. Select your preferred stablecoin from the drop-down menu offering the types of crypto you can purchase.
6. Select the wallet you wish to be debited from (Naira, Cedis or Shellings).
7. Crosscheck all the relevant details and select “Buy” if it checks out.
8. Lastly, your Bitmama crypto wallet will be credited instantly with the purchased stablecoin.
Purchasing stablecoin from the Bitmama P2P exchange
Follow the steps below to purchase stablecoins from Bitmama P2P exchange:
1. Download the Bitmama app for Android or iOS, register and log in.
2. Navigate to the verification page in your ”Account” section. Click on the verification button to submit the necessary documents and verify your account up to level 3.
3. Select “P2P” in the bottom menu on your screen
4. Lastly, proceed to browse the available listing and choose the stablecoin deal that works for you. Select “Buy” to initiate the transaction and complete the process.
Which is the best stablecoin?
The largest stablecoin by market cap and most popular is Tether (USDT). It is tied to the U.S. dollar at a ratio of 1:1 and supported by gold reserves. Also, it has consistently been in the first five cryptocurrencies based on market cap. You can find USDT on Bitmama.
On a final note, although stablecoins can be less volatile in price than other kinds of crypto, they still operate on newer technology. This makes them prone to unknown bugs or different vulnerabilities, therefore, be careful of the platform you purchase them from.
As the best crypto exchange app in Nigeria, Bitmama offers a secure marketplace for crypto enthusiasts to trade stablecoins. Perform activities like crypto exchange, crypto staking, and creating virtual dollar or crypto cards for online payment.
Get started today by downloading the Bitmama app on Android or iOS.
