Stablecoin: Why We Need It
by Mint Dice Bitcoin CasinoThe cryptocurrency market is incredibly fast-paced, with coins often fluctuating in value several times a day. This is evident in the case of Bitcoin's price, which saw an increase from a little above $5,000 to a record high of $19,783.21 in December 2017. The tendency of the market to fluctuate frequently is what draws investors in. This is because market volatility is a sign that as much as there could be a decrease in the value of a token, there could also be an increase that leads to profit.
Unfortunately, this volatility factor of the cryptocurrency market which endears it to investors is also a weakness when considering its real-world applications. Due to the rate at which the value of coins fluctuates, it would be impractical to use them for everyday purchases in which prices are fixed because of the lack of stability. For example, the price of a meal could be set at a certain amount of BTC, equal in value to $120. The next day the same amount of tokens may be worth $150 or even $100. In such a case, businesses, as well as consumers, would experience losses in purchasing power and there could be chaotic economic consequences.
For software applications that receive cryptocurrency payments, the constant fluctuation in value presents a problem as well. Developers are faced with the challenge of fixing prices for app purchasing power. To effectively accomplish this, they would need a cryptocurrency that is immune to market volatility. This currency would also need to be secure, private and scalable due to the need for global availability. The solution to this problem can be found in an emerging category of cryptocurrency known as
What is Stablecoin?
A
In the case of purchasing a meal using
How Do Stablecoins Work?
There are three currently available models of Stablecoins: Fiat-collateralized model, Crypto-collateralized model, and Non-collateralized model.
Fiat-Collateralized Model
Stablecoins based on the fiat-collateralized model are tethered in value to a reserve of fiat currency such as the U.S dollar in certain ratios. These ratios can often be 1:1, signifying that for every
Similar to how the gold standard worked, each token can be exchanged for the number of underlying assets it represents, creating stability in the system. The fiat-collateralized model is also known as IOU issuance model and apart from fiat currency, coins can be tied to assets like gold or silver. Some companies that issue
Advantages
- The model is simple and easily understandable by users.
- Coins in this model are stable even in the event of a cryptocurrency meltdown because they remain intact within a fiat reserve.
- Since the reserve is off-chain, the risk of fraud and exposure to hackers is minimized. For example, Stably, an issuer of
stablecoins requires its customers to undergo an anti-money laundering application process before they are issued tokens.
Disadvantages
- This model requires a centralized reserve which counteracts the decentralized nature of cryptocurrency. The reserve acts as a central bank, controlling the supply of coins.
- Transparency is also limited due to the centralization of the reserve because transactions carried out by the issuing company cannot easily be tracked on a blockchain. Users have to rely on the regular, expensive audits carried out on these companies.
Crypto-Collateralized Model
In contrast with the fiat-collateralized model,
For example, 50
Advantages
- The crypto-collateralized model is decentralized, making it easier to liquidate
stablecoins at any point. - Transactions carried out in this model are transparent, trackable and do not require audits.
- This model does not require a central reserve that dictates supply.
Disadvantages
- During a cryptocurrency price crash where the value of the collateral coin drops below the minimum underlying collateral, the
stablecoins are automatically liquidated. - The model is more complex than its fiat counterpart and can prove difficult for users to understand.
- Capital is used inefficiently in a higher ratio than the tethered coin.
- It is not as stable as the fiat-collateralized model.
Non-Collateralized Model
This model eliminates the need for
If the trading price rises above $1, it means that there is a shortage of supply. This causes the smart contract to execute, and auction more coins on the open market to return the price to $1. After auctioning coins, the smart contract is left with profits, also known as seigniorage. If the trading price falls below $1, the smart contract uses the seigniorage to buy up coins that are already in circulation. This creates scarcity and increases the trading price of the coins.
Advantages
- It is independent and completely decentralized.
- No collateral is required to tether the
stablecoins - The model uses a self-regulating mechanism which ensures continuity of function without external influence.
Disadvantages
- It is complex.
- In the event of a cryptocurrency price crash, the
stablecoins cannot be liquidated. - The system requires continuous growth to function. Any long-lasting decline in price may cause users to lose trust.
Final Thoughts
The problem of market volatility has stood in the way of the mass-adoption of cryptocurrency for a long time. Stablecoins solve this problem and make it easier and safer to use digital coins for everyday purchases, including app payments. Although there is currently no perfect
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Created on Sep 21st 2020 15:35. Viewed 319 times.