What Is A Stablecoin?

What is a stablecoin?

As mediums of exchange, cryptocurrencies are excellent from a technological standpoint. However, the fluctuations in their value have ultimately rendered them highly risky investments, and not ideal for making payments. By the time a transaction settles, coins can be worth significantly more or less than they were at the time they were sent.

But stablecoins have no such problem. These assets see negligible price movement and closely track the value of the underlying asset or fiat currency that they emulate. As such, they serve as reliable safe-haven assets amid volatile markets.

There are a number of ways in which a stablecoin can maintain its stability. In this article, we’ll discuss some of the mechanisms used, their advantages, and their limitations.

How do stablecoins work?

There are a few categories of stablecoins, each of which goes about pegging their units in different ways. Below are some of the most common types of stablecoin.

Fiat-backed stablecoins

The most popular kind of stablecoin is that which is directly backed by fiat currency with a 1:1 ratio. We also call these fiat-collateralized stablecoins. A central issuer (or bank) holds an amount of fiat currency in reserve and issues a proportionate amount of tokens.

For instance, the issuer may hold one million dollars, and distribute one million tokens worth a dollar each. Users can freely trade these as they would do with tokens or cryptocurrencies, and at any time, the holders can redeem them for their equivalent in USD.

Crypto-backed stablecoins

To acquire this kind of stablecoin, users lock their cryptocurrency into a contract, which issues the token. Later, to get their collateral back, they pay stablecoins back into the same contract (along with any interest).

Algorithmic stablecoins

Stablecoins use cases

This list is far from exhaustive. The market for stable digital currencies is broad, something evidenced by the proliferation of hundreds of stablecoin projects.

BUSD vs USDT

BUSD is a stablecoin developed by Paxos in partnership with Binance. Paxos are also issuer of other stablecoins Paxos Standard (PAX), HUSD and PAX Gold (PAXG).

BUSD are approved and regulated by the New York State Department of Financial Services and is 100% backed by U.S. dollars held in FDIC-insured U.S. banks. Also, an auditing firm (Withum) audits BUSD monthly to check if the money held in banks matches the BUSD supply, which you can check out here. On the other hand, USDT is not regularly audited. The last audit published on Tether’s site dates back to 2018, which was carried out by Sporkin & Sullivan LLP. But they do publish the value of their reserves daily which can be seen on this page.

Another difference between BUSD and USDT is that the reserve that backs USDT is held in offshore banks which are regarded as less trustworthy. To date, there have been also many allegations about Tether, a summary can be found here.

So one can say that BUSD is safer than USDT. This is actually true. But, if you are an average trader, it really does not matter whether you trade BTC/BUSD pair or BTC/USDT pair.

But, if you want to hold really large sums of money in the form of stablecoins, holding only BUSD or splitting the money between BUSD and USDT might be a better idea. Also, trading coin-margined futures instead of USDT-margined futures on Binance or other exchanges might be safer in case a catastrophic event related to Tether may happen.

Other than that, there is really no any difference between BUSD and USDT. If you are an average trader, you should rather look for volume, arbitrage opportunities, etc.

USDC vs USDT

After USDT, USD Coin (USDC) is the largest stablecoin by market cap. USDC is governed by Centre, a membership-based consortium, of which Circle and Coinbase are founding members.

So USDC is basically a stablecoin launched and governed by Circle and Coinbase. USDC is also audited montly by an auditing firm, Grant Thornton LLP, just like BUSD. The company behind USDC follows US regulations and works with established banks and auditors, which is not the case with Tether (USDT). So USDC, just like BUSD, is safer and more transparent than USDT.

If we compare USDC to BUSD, both stablecoins are actually pretty similar as they both follow US regulations and work with US banks and auditors.

Again, if you are a trader, you can trade both USDC and USDT pairs. It really does not matter that much. But, if you will open large positions on cryptocurrencies, you can prefer coin-margined products instead of USDT-margined ones. Also, you can hold more than one stablecoin instead of depending on one to mitigate risks.

Stablecoins pros and cons

Although they have some disadvantages, stablecoins are a critical component of the cryptocurrency markets. Through a variety of mechanisms, these digital currencies can remain more or less steady at set prices. This allows them to be used reliably not only as mediums of exchange, but as a safe haven for traders and investors.