What are Stablecoins? Are they more stable than Bitcoins?

Summary

• The main purpose of introducing stablecoins is to manage the extreme price volatility by tracking the issues of relatively more stable asset classes.
• Being backed by real assets, their price volatility is quite subdued, making them conservative investors’ preferred choice over other cryptocurrencies.
• The price volatility of Stablecoins is very low, which also makes is relatively difficult to make huge gains.

Recently, stablecoins have attracted a lot of attention in the financial industry. Just like cryptocurrencies, Stable coins are emerging as one of the favourite options for first-time investors. However, before investing in this asset, one must fully understand the potential risks and benefits of stablecoins.

The investors of Bitcoins can’t get away with extreme price volatility, which affects their invested amount to a great extent. The main purpose of introducing stablecoins is to manage this extreme price volatility by tracking the issues of relatively more stable asset classes, such as traditional fiat currencies. These real assets are designed to have very low-price volatility.

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Unlike Bitcoin, stablecoins are backed by real and stable assets such as the US dollar and gold. However, these coins can easily be created or destroyed to keep their price in check. As of today, there are already quite a number of stablecoins in the circulation, but not as much as other cryptocurrencies having no real backing.

Stablecoin is essentially a slight variation cryptocurrency in the sense that it derives its value from some external real asset. This means that unlike fiat money, they are backed by a reserve asset like fiat currency during the Gold Standard Era.

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The need for Stablecoins

A cryptocurrency is a type of virtual currency, which relies on decentralised networks through the use of blockchain technology. Users have lauded the processing system, which is seamless, instant, and secure.

Since the blockchain technology is decentralised and in the public domain, it makes counterfeiting or duplication almost impossible. Cryptocurrency is s relatively newer asset class, having almost no government control on its price, which makes it a highly volatile asset class.

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The intraday price movement of cryptocurrencies can be quite volatile. For example, the price of Bitcoin peaked in December 2018 to around US$19,700, and within the next two months, its price saw a meltdown and eroded almost two-thirds from the high. The uncertainty surrounding these erratic price movements render cryptocurrencies unsuitable for everyday use by retail investors or non-experts.

This is where stablecoin comes into picture. Being backed by real assets, the price volatility is quite subdued, making it a preferred choice over other cryptocurrencies.

Pros of investing in Stablecoin

As mentioned earlier, the price fluctuations of stablecoins remain very low and stable, unlike Bitcoin and other cryptos. The chances of a complete value erosion are highly unlikely as fiat currencies back them. This is probably the biggest benefit of investing in a stablecoin.

The price volatility of Bitcoin also prevents a lot of large funds and other smaller investors making investments. So, for them, a stablecoin can be a good alternative to invest in the crypto space.

Using stablecoins could be more convenient for people as they can use it as a currency more than other high-risk digital currencies. It also offers transparency as they are backed by regular audits.

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Cons of Investing in Stablecoin

The price volatility of stablecoins is very low, which is also a relatively difficult factor for one to make huge gains. This could prevent more experienced investors or high-risk takers to invest in stablecoin. Stablecoins are only suitable for conservative investors/traders.

Fiat currency-backed stablecoins are generally the most constant stablecoins. Nevertheless, their stability is neither preferred nor profitable for a long-term investment strategy. In fact, it is hard to tell whether these stablecoins would be able to beat high inflationary period, and keep long-term investors to invest in them.

External audits are required to ensure that the asset that has backed the stablecoin has been fairly accounted for. Also, some regulations could come in way as these involves fiat currency.

Conclusion

Due to real assets backing them, stablecoins are considered very safe for long-term investors. According to some experts, the safest stablecoins are Dai and Gemini Dollar. However, if one is willing to take higher risk and can sustain higher volatility, then other cryptocurrencies have a higher potential for delivering good returns.  

Read More: All you need to know about stablecoin