With all the volatility in the cryptocurrency space these days, everyone in the markets is looking for ways to find some price stability. Investors have several different options when it comes to finding a more stable asset, including trading back to fiat currency for a while, but what about keeping their assets in the crypto markets? That’s where «stable coins» come into play.
There are always differences between crypto projects and what the specific coins have to offer, but stable coins introduce an entirely new advantage over traditional cryptocurrencies. If to compare the two directly, the advantages become obvious in terms of mitigating volatility.
Looking at the history of the movement of traditional cryptocurrencies and the underlying blockchain technology, we know that the value and price attributed to the coins derives from both utility of the coin or token, as well as acceptance by others in the markets. This leaves a lot of room for drastic price movement.
For better understanding the significance of the difference between the two types of coins, investors really should know how cryptocurrencies work. Knowing the technology behind the new asset class is already a prerequisite for most investors as more knowledge aids in better investment decisions. After understanding the fundamentals of traditional cryptocurrencies, it makes it easier to understand why stable coins exist and the need they fill in the market. The key difference is that traditional cryptocurrencies, like fiat, are not «backed» by anything. Instead, the cost of the cryptocurrency depends on the use-case and acceptance by others.
Unlike more traditional cryptocurrencies, stable coins offer all the traditional benefits of cryptocurrencies like blockchain technology, a distributed ledger, and a decentralized network, but with one key difference: asset backing.
Stable coins don’t rely solely on utility and acceptance for their cost. Instead, they are like original fiat currencies once backed by gold. Stable coins are a cryptocurrency that have been ‘pegged’ to another asset. That asset can be anything: a fiat currency (like the USD with Tether), precious metals (like gold and silver with Quintric), and everything in between.
Stable coins offer a significant inherent value to each coin and token by having them represent ownership of another asset. For instance, a gold-backed cryptocurrency will always represent a minimal amount of value: a specific denomination of gold. Because of that backing, even if the markets were to decline as a whole, the backed assets are still worth the amount of gold each represents.
There are a few different ways to run a pegged asset, but typically there are a specified amount of coins available for purchase and the issuing authority has the corresponding amount of assets backing them vaulted for storage. When done correctly, investors can go to the issuing authority and exchange their coins for the asset on demand.
With a price-stable cryptocurrency in a portfolio, investors have the ability to protect their investments from drastic price movements during uncertain times in the market. Stable coins play a crucial role in offering traders and investors an important tool for risk reduction.