What are stablecoins and what should you know about them before investing?

almost 2 years ago (Edited)

Define Stablecoin

They are price-stable digital assets that behave somewhat like fiat, but also have the easy movability and utility of cryptocurrency.
Source

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What does that mean?

Price Stable Digital asset

It means unlike cryptocurrency, a stable coin is always worth about the same amount of US Dollars, within a range of 2-4 cents.
It means that just like cryptocurrency, a stable coin can be transferred anywhere in the world, over the blockchain, in seconds or minutes.

What problem do they solve or why are they needed?

Volatility

In a word cryptocurrency tokens have price volatility.
If your an experienced cryptocurrency investor you may have already started laughing.
Why? Because saying cryptocurrency prices are volatile is like saying a Hurricane is windy, it seems like an understaement. LOL
Stablecoins are the opposite of cryptocurrency tokens.
People buy cryptocurrency hoping the price or value will go up.
But stablecoins are designed for their price to stay the same.
People buy cryptocurrency to grow their money, but stablecoins are designed to preserve the current value of your capitol.
Lastly, Cryptocurrency tokens are only available on a limited number of exchanges. While stablecoins are widely available on almost all exchanges.

So that is the definition of a stablecoin, and the reason investors use them.

Stablecoins are the most traded assets in all of cryptocurrency.
Now lets look at the different types of stablecoins, so you can understand which ones might be more risky investments then others.

Types of Stablecoins

The types of stablecoins are defined by the type of collateral upon which their intrinsic value is based.

First, there is U.S. Dollar backed or Fiat backed (currencies other then the US Dollar. This type of stablecoin depends on a bank or other centralized entity, but can offer banking protects other stablecoins don't offer. This is like USDT or Tether. This is considered a very safe stablecoin.
Second is cryptocurrency backed, like Bitcoin or Ethereum. An example of this is Dai. The stablecoin doesn't rely on a centralized entity like a bank, but instead relies on software code called smart contracts. These type of stablecoins are also backed by much more cryptocurrency value then the value of the stablecoin. So they are called over-collateralized. So 60 dollars worth of Dai is backed by about 100 dollars worth of Ethereum or Bitcoin. And the underlying asset will immediately be sold before any price drops which would be less then the amount of the stable coin value.This is considered a very safe stablecoin, but perhaps not as safe as the Fiat backed stablecoin.

Third is commodity or physical assets like gold, or oil. There are two big stable coins UST Gold or PAX stable goind based on gold. This seems very safe, but these assets display similar volatility to cryptocurrency and they are not over collateralized, so 100 dollars worth of gold equals 100 dollars worth of the stablecoin. This is not overcollateralized, so there is no protection against volati;ity. People don't think of gold as being volatile, but it is, so it is questionable whether gold backed stablecoins are actually safer then cryptocurrency backed stablecoins. The world is a strange place, and things are not always what they seem or what we expect.
Fourth, is algorithmic stablecoins.The price of these stablecoins is attached or pegged to the US Dollar usually, but they are backed by a software algorhythm, which modulates the supply of the token to respond to market forces seeking to increase or decrease the value of this stablecoins. These may or maynot be tied to another cryptocurrency token in some way, but the variation between the different algorhythmic stablecoins makes simple comparisons difficult and inaccurate.
However, these are historically the most likely to fail and lose their value, as in go to zero. So you should invest in them knowing what steps the creators or managing team took to protect the stablecoin from market manipulation.

Lets talk about the stablecoin the Hive Backed Dollar

The Hive Backed Dollar is an algorhythmic stable coin, and it is 4 years old, it's software algorhythm is the result of four years of software tweaks and experience with multiple bear and bull markets.
@taskmaster4450 did an artickle recently about it, so I have added a snippet of that valueable information to this post:

Since HBD, like UST, is an algorithmic backed stablecoin, people want to draw parallels between the two. This usually ends with people concluding the same thing could happen to HBD. While we can never say definitively what will happen, we can analyze the different features in place.

-Source:This is the link to @taskmaster4450 article, which discusses in detail the differences between thwe Terra Luna Stablecoin UST and HBD.You can find it here:

Last words

Today we reviewed the definition of stablecoins, their utility, their types and briefly scratched the surface of determining their relative safety.
I hope you found this useful.