By the end of 2021, centralised cryptocurrency exchanges reported trading volumes of more than US$14 trillion, compared to a mere US$1.8 trillion in 2020. The 689% increase comes as no surprise as mainstream adoption of cryptocurrency soared over the years, with low barriers of entry to many bright-eyed casual investors.
Among more than 10,000 cryptocurrencies, stablecoins like the USD Coin (USDC) are popular and widely-adopted, thanks to their stability in the volatile cryptocurrency market.
Stablecoins are one of the most talked about assets in the cryptocurrency space. But for all the bustle, few people have a good sense of what they are and how they work.
A stablecoin is essentially a cryptocurrency that is designed to maintain an approximate buying power (or value) pegged to a specific fiat currency. As the name implies, it’s meant to be more stable than standard cryptocurrencies’ price fluctuations.
These coins seek to achieve this level of stability by tying the coin’s value to existing assets such as gold or fiat currencies. They’re generally considered a release valve for volatile cryptocurrencies, allowing users to move in and out of different cryptocurrencies without a significant impact on price.
For example, one USDC can always be redeemed for one US Dollar, giving it a stable price. Similarly, one XSGD and one XIDR can always be redeemed for one Singapore Dollar and one Indonesian Rupiah respectively on the StraitsX platform.
There are four types of stablecoins:
When you think of the word “stablecoin”, the first few that you think about are probably USDC, XSGD, and XIDR, among many others. Such stablecoins are backed (or collateralised) at a 1:1 ratio with a fiat currency like the US Dollar, the Singapore Dollar, or the Indonesian Rupiah. Theoretically, for each stablecoin that is minted, there should be real fiat currency safeguarded in a bank account behind it.
This is the case for XSGD and XIDR, which are fully backed by their respective fiat currencies at a 1:1 ratio. The fiat backing XSGD and XIDR are safeguarded in a regulated financial institution.
As its name implies, commodity-collateralised stablecoins are backed by physical assets such as precious metals, oil, and real estate. Unlike fiat-backed stablecoins, commodity-collateralised stablecoins such as Digix (DGX) or Paxos Gold (PAXG) are more prone to price fluctuations due to the fluctuation of the underlying asset.
It’s a bit confusing to think about backing a stablecoin with other cryptocurrencies, because it’s like, “Why would I want to back my stablecoin with other types of crypto, when the point of the stablecoin is to be stable?”
The idea behind a cryptocurrency-collateralised stablecoin is to maintain the value of the asset that it’s pegged to, since the underlying asset might be volatile. This is done by over-collateralising the underlying asset of the cryptocurrency-collateralised stablecoin.
For example, Dai (DAI) is a stablecoin that attempts to maintain a stable 1:1 value with the US Dollar. However, unlike USD Coin which is backed by the US Dollar held in a regulated financial institution, Dai (DAI) does it by over-collateralising Ethereum-based assets in a smart contract. This helps Dai maintain a close-to 1:1 value to the US Dollar.
Amongst all the listed stablecoins so far, algorithmic stablecoins are the most unusual. Whilst the above mentioned stablecoins tie their value to an asset – be it physical or digital – algorithmic stablecoins gain their price stability through specialised… algorithms. These algorithms can be paired with smart contracts to manage the supply of stablecoin tokens in circulation by minting or burning collateral, so that the price of the stablecoin token remains constant.
Such an example would be TerraUSD (UST). TerraUSD (UST) uses Luna (LUNA), Terra’s native cryptocurrency, as collateral. To mint one TerraUSD (UST), you would have to burn US$1 worth of Luna (LUNA) tokens on the Terra blockchain network. This is done by its algorithm.
Imagine you’re paying for a non-fungible token (NFT) with Bitcoin (BTC) or Ethereum (ETH), but the value of these cryptocurrencies change everyday. Their inherent value is speculative, which makes it unsuitable for regular transactions. Hence, stablecoins aim to marry the best of fiat currency, which is stability, with the best of blockchain technology, that is traceability.
Similarly, stablecoins are advantageous for investors in the volatile cryptocurrency market. Unlike stock markets, cryptocurrency exchanges do not close after a certain time. They operate 24 hours a day, 7 days a week. With stablecoins, investors can move their money in and out at a moment’s notice, as well as between cryptocurrency to exchanges globally without exiting to fiat
This is as good as holding a part of your cryptocurrency portfolio in cash, where you can buy a cryptocurrency immediately, without the tedious transferring of fiat from your bank account to your cryptocurrency exchange account.
While stablecoins may not be as well known as Bitcoin (BTC) or Ethereum (ETH) yet, their functionality has proven their worth. The market cap of stablecoins has grown from around US$1 billion in 2018 to more than US$160 billion by the end of 2021.
Bitcoin (BTC), Ethereum (ETH), and other similar cryptocurrencies like Cardano (ADA), Solana (SOL), and Terra (LUNA), among many others, remain too speculative and volatile for general use as a medium of exchange by the public. They can lose or gain considerable value in a matter of hours.
This is where stablecoins come in to solve the volatility problem by being pegged to a fiat currency, like the XSGD to the Singapore Dollar and XIDR to the Indonesian Rupiah. This ensures that stablecoins guarantee a fixed exchange rate between their tokens and fiat currencies. At StraitsX, every single XSGD and XIDR is backed by a Singapore Dollar or Indonesian Rupiah, respectively, and all such SGD and IDR are fully safeguarded and held by a regulated financial institution.
As the cryptocurrency landscape continues to evolve, stablecoins remain a safe and convenient asset for many investors venturing into the digital currency market. The technology to develop user-friendly custodial and non-custodial wallets are also in the works and are gradually improving.
StraitsX lets you enjoy the benefits of stablecoins: mint, swap, and redeem with XSGD and XIDR with other stablecoins within the StraitsX Ecosystem and our DeFi partners.
Note: If you are a high net worth individual, or institution, you can take advantage of StraitsX’s OTC Desk feature that offers deep liquidity and OTC block trades.
StraitsX and our DeFi partners are specially catered to our Indonesian and Singaporean users with our native support of XSGD and XIDR. This allows our regional investors to trade in their home currency to minimise transaction fees and slippages, instead of, traditionally, with the US Dollar (USD) that carries conversion fees.