Stablecoins: less volatile virtual money

When the first cryptocurrency – the Bitcoin – appeared in 2009, very few could have imagined that the technology required for its operation – the blockchain – would end up being more important than the virtual currency itself.

The enigmatic Satoshi Nakamoto revolutionized the world of Internet payments: for the first time a decentralized currency was being created, which neither banks nor states could control. However, one of the rules of money was broken: having a backing. Yes, Bitcoins are bought with legal tender, as well as with other cryptocurrencies, but behind a Bitcoin there are only algorithms that control its mining so that its production is limited and scarce (with a date and maximum number of virtual coins) and its value is only determined by the market, the price of its supply and demand.

Who has not heard about that fateful purchase of two pizzas for 10,000 Bitcoins in 2010? It even has its own ephemeris: Bitcoin Pizza Day, on May 22. Based on this premise, it is very easy to understand that the volatility of Bitcoin and other virtual currencies is so high that it is impossible to use them to buy goods and services as we would do with fiat money (euros, dollars and any other legal tender).

It is logical, if our salary is in legal currency (euros, dollars, etc.) and with it we buy virtual currency, the exchange rate between fiat currency and cryptocurrency will always be present afterwards, when making any purchase or sale. The huge fluctuation in its exchange rate to euros (or any other currency) discourages its use as a means of payment; no one wants to make the mistake of two pizzas for 25 million dollars.

Stablecoins are not cryptocurrencies, but tokens.

At this point it is worth pointing out a slightly more technical concept. Stablecoins are really tokens. To explain it very simply, let’s think of another token that we all know: casino chips, which only have value within the casino.

Well, a token or digital asset represents a given value (for example, a dollar) but, instead of having a physical format -a plastic casino chip-, it has some characteristics defined on the blockchain of a cryptocurrency. To achieve this, programs or contracts are used on the block chain, usually Bitcoin or Ethereum, that determine what a token is and how it can be used.

Stablecoins: less volatile virtual money

Stablecoins, or stable cryptocurrencies, aim to combine the best of both worlds, the virtual and the physical, and now they are less volatile. To achieve this, these tokens have collateral, i.e., they are backed by legal tender -mainly US dollars-, material goods or another cryptocurrency. Or they use a smart contract precisely to avoid high fluctuations. Let’s look at the two types:

Centralized stablecoins.

The backing or collateral of these stablecoins are the deposits made when buying them. That is, if we buy, for example, a USDT, we are depositing a US dollar in the Tether Limited platform, which theoretically should hold those dollars as collateral for all its cryptocurrencies. Something similar happens with USDC, from Coinbase and Circle, or with TUSD from TrustToken, among others.

Decentralized stablecoins

Stablecoins are intended to be less volatile, we already knew that. But in this case, to avoid depositing their value in an entity, as happens with centralized stablecoins, decentralized stablecoins back their value using reserves of another cryptocurrency as collateral. The two main ones are USDN (Neutrino Dollar), which are tokens on the Waves cryptocurrency blockchain, and DAI, which are tokens on the Ethereum blockchain.

Stablecoins are opening a new horizon for cryptocurrencies, as decentralized digital currencies but linked to a fiat currency. Proof of this is Visa’s patent in the United States where the payment giant registered a “digital fiat currency” in May 2020, in the midst of the COVID-19 pandemic.

 

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