The cryptocurrency ecosystem has come a long way.
First, it was Bitcoin; then Ethereum surfaced, and now, with the rise of cryptocurrency wallet development services, Statista reports that there are over 9,000 cryptocurrencies in existence as of 2024. That number has probably increased since then.
Now, when you consider the immense benefits these alternative currencies offer, it makes sense to think new cryptocurrencies are being released regularly because of their potential benefits. But, the only factor negating that argument is that cryptocurrencies, despite their good qualities, are inherently volatile.
A cryptocurrency launches today, gains some media buzz, and has a high value. However, after a couple of days, its price has dwindled significantly.
Consequently, this concern has significantly stalled crypto adoption — not for long, however.
Stablecoin development has put a spin on that. Since their launch, stablecoins have quickly become an industry favorite, playing major roles in the crypto ecosystem.
But have they been influencing the development of new cryptocurrencies though?
Find out in this article as we examine the primary purpose of stablecoins, the relationship between stablecoin and cryptocurrency, and the types of stablecoins out there.
Dig in!
What is the Primary Purpose of Stablecoins?
In simple terms, stablecoins exist to solve the issue of crypto price volatility. They emerged because of the high volatility associated with traditional cryptocurrencies like Bitcoin and Ethereum. Due to their decentralized, peer-to-peer transaction system, these cryptocurrencies have the potential to revolutionize traditional financial systems, but they are also very prone to extreme price volatility.
For example, Bitcoin recorded a 10-day volatility of more than 100% in 2022. To give you more context on what that means for the everyday user, a merchant who decides to use Bitcoin for payments could receive a certain worth of Bitcoin today, and 10 days later, their coin has either doubled or halved in price.
Now, that’s not reliable for business, is it?
Enter stablecoins, a unique category of cryptocurrency with a “stable” value tied to the value of other currencies, commodities, or financial instruments. This means their worth or value is tied to the value of a more fixed reference, such as the US dollar or commodities like gold.
So, instead of their value fluctuating due to market sentiments like Bitcoin and Ethereum, they remain tied to the chosen external reference. In fact, most of them are usually 1:1 pegged to fiat currencies like the USD.
Stablecoins offer the best of both worlds by combining the power of blockchain technology and the financial stability of traditional fiat systems. This makes them a better fit for practical everyday use compared to other types of cryptocurrencies.
Now, while stablecoins were arguably created just to be a “parking space” for crypto volatility and as a bridge to trade crypto assets, they’ve evolved over the years and have found new and interesting use cases. In fact, quality crypto token development services like Debut Infotech have mastered the art and science of using them for different specific purposes.
Later in this article, we will explore these different use cases and their role in the wider cryptocurrency ecosystem.
But for now, let’s get more context on the various types of stablecoins around so we can fully explore their impact.
Are you ready?
Types of Stablecoins
Remember we mentioned that the value of stablecoins can be pegged to different external references?
Well, a stablecoin’s external reference determines the category in which it falls. The following are the types of stablecoins based on the assets used to stabilize their value:
1. Fiat-Collaterized Stablecoins
As the name implies, these are stablecoins whose value is pegged to specific fiat currencies, such as the US dollar, Euros, or any other national currency. They are often pegged at parity with the chosen fiat currencies.
More importantly, the stablecoin development company issuing such stablecoins often guarantees the coin’s value by maintaining a reserve of the selected currency. Some of the most popular fiat-collateralized stablecoins include:
- Tether (USDT) pegged to the US dollar
- True USD (TUSD) – pegged to the US dollar
- USD Coin (USDC) – Pegged to the US dollar
- Stasis Euro (EURS) – Pegged to the Euro
2. Commodity-backed Stablecoins
Once again, their name tells you all you need to know about this type of stablecoins. They are stablecoins whose value is pegged to commodities and physical assets like crude oil, silver, gold, or other tangible commodities that have a relatively fixed value.
Popular examples of commodity-backed stablecoins include the following:
- Paxos Gold (PAXG)
- Tether Gold (XAUT)
3. Crypto-collateralized Stablecoins
These are stablecoins backed by other cryptocurrencies but usually pegged to other fiat currencies. Being backed by cryptocurrency means that the coin issuers hold reserves of cryptocurrencies as collateral to maintain their value. However, the market value is pegged to the value of established fiat currencies.
The following are some prominent examples of crypto-collateralized stablecoins:
- MakerDAO’s DAI
- Synthetix USD (sUSD)
- Frax Stablecoin (FRAX)
- Decentralized USD (DUSD)
4. Algorithmic Stablecoins
Instead of just arbitrarily pegging their value to fiat currencies or commodities, algorithmic stablecoins control the coin’s supply using sophisticated algorithms. Now, these coins can either hold reserves or not. But the key defining characteristic here is that the coin’s value is determined by a programmed mechanism that aims to balance the coin’s demand and supply, kind of like central banks do.
Prominent examples of algorithmic stablecoins include:
- Ampleforth (AMPL)
- Frax (FRAX)
- Empty Set Dollar (EST)
- TerraUSD (UST), which has now collapsed.
By observing the unique peculiarities of the various types of stablecoins discussed above, you might have noticed some vital benefits of stablecoins to the crypto ecosystem. However, in the next section, we’re going to focus on these vital roles.
What Role Do Stablecoins Play in the Cryptocurrency Market?
By leveraging the speed and security features of blockchain technology and eliminating the volatility of most cryptocurrencies, stablecoins have been able to serve the following purposes in the crypto market.
1. They Serve as Liquidity Providers in DeFi
The blockchain’s permissionless networks and decentralized structure have helped create a host of professional services involving lending, investment, and asset management. Collectively, these services can be regarded as decentralized finance (DeFi).
However, they are plagued with certain challenges that hinder their wider adoption. Some of these challenges include volatility and accessibility.
For instance, decentralized exchanges and lending protocols can’t totally rely on fiat currencies or cryptocurrencies to facilitate transactions. Fiat currencies negate the idea of moving away from traditional finance systems, while cryptocurrencies often experience huge price swings.
Stablecoins like Tether, USD Coin (USDC), and many others help provide liquidity in DeFi applications by making sure there is more money available for transactions.
DeFi applications lack liquidity because many market participants are concerned about incurring losses due to price swings.
Therefore, by maintaining a steady value, everybody feels more comfortable. Both lenders and borrowers know exactly how much they’ll earn back or get, respectively. Consequently, this eliminates risks from financial transactions, making them better suited for automated trading pools. More so, price stability helps smart contracts work more accurately.
In general, stablecoins are a reliable source of funds that keep DeFi systems running smoothly.
2. Crypto Asset Trading
Cryptocurrency price fluctuations also significantly impact crypto asset trading by introducing a lot of risk and uncertainty. When these are not managed effectively, they can lead to liquidity issues in the market at large, especially for smaller cryptocurrencies with lower trading volumes. Furthermore, it is also difficult to facilitate direct conversions between fiat currencies and cryptocurrencies.
In response to these challenges, stablecoins function as a bridge between fiat currencies and cryptocurrencies. For one, conversions between fiat currencies and stablecoins are more straightforward and quicker than those between unbacked cryptocurrencies like Bitcoin and Ethereum. As such, it becomes easier to convert currencies during crypto asset trading. Evidently, the trading volumes of stablecoins surpassed those of other cryptocurrencies in 2021. Tether (USDT) was a major driver for this trend, as it was involved in half of all trades involving Bitcoin and Ether.
Furthermore, stablecoins help traders reduce their exposure to cryptocurrency volatility when they need stability during transactions or when holding funds between trades. So, transactions are smoother and faster. Additionally, there’s a predictable value transfer across different platforms without needing frequent conversions between fiat currencies and volatile crypto assets.
3. Means of Payment
Price fluctuations also significantly hinder crypto adoption as a means of payment because it just doesn’t make sense to be uncertain about the value of your means of exchange. Both vendors and buyers are concerned about potential losses when the market swings. Clearly, stablecoins alleviate these concerns by offering a stable value.
But that’s not the only advantage stablecoins offer. By leveraging the blockchain’s transparency and immutability, stablecoins also outperform traditional financial systems by guaranteeing the security and trust of both businesses and users.
Consequently, stablecoins have established themselves as better alternatives to unbacked cryptocurrencies for e-commerce payments. They are stable, faster, secure, and relatively cheaper.
Stablecoins also simplify the remittance process during cross-border payments with better affordability because of their decentralized nature and reliance on blockchain technology
4. Store of Value
Stablecoins are less volatile than other cryptocurrencies, which means they can preserve purchasing power, especially in regions experiencing high inflation or extreme economic instability. Since they are pegged to valuable fiat currencies and commodities, they allow individuals to shield their assets from the volatility of local currencies due to economic unrest.
Furthermore, the blockchain’s guarantee of global accessibility has made stablecoins a worthy alternative for individuals in emerging markets with limited financial instruments. Most people in this environment want to connect to the global financial ecosystem and access the US dollar. However, due to the unstable economic climate, this is not often the easiest task.
Stablecoins provide an alternative path towards that stability they so much crave.
Conclusion
So, how have stablecoins influenced the development of new cryptocurrencies, you say?
Although crypto adoption is not yet at the maximum, it is definitely on an upward trend. And while stablecoins can’t take all the credit for that, they’ve definitely catered to some of the concerns users had about cryptocurrencies in general.
As such, they have been providing liquidity in the DeFi ecosystem, bridging fiat and cryptocurrencies, serving as a means of payment, and putting in a good shift as an important store of value.
So, different token issuers have been comfortable venturing into crypto token development because stablecoins handle most of these loopholes. Likewise, we’re also seeing more businesses adopting stablecoin and cryptocurrency payments as the infrastructure matures.
The key is that stablecoin development has been so important in shaping new cryptocurrencies and the crypto ecosystem as a whole. And from all indications, there’s more to come in the coming years.
Interesting times ahead!
