Crypto is in a bull rush right now, and there is all kinds of speculation about how far the market will reach this time.
With the value of Bitcoin tantalisingly close to six figures, there is a feeling that it is a matter of when rather than if it will reach the $100,000 mark. Regardless, given that it started the year valued at less than half of its current value, 2024 has been a banner year even by the standards of previous booms.
The successful approval of Bitcoin ETF funds is certainly a major part of this, allowing people not invested in the crypto market to invest in a more structured and secure way, particularly with reported attempts to create crypto ETFs which are designed to be more risk-averse.
This is the most recent attempt to create stability and opportunity for people in a market often characterised as volatile and fast-moving, but it is far from the only one.
An underappreciated cog in the wheel of decentralised finance is stablecoins, cryptocurrency tokens that provide some degree of stability and liquidity between the on-ramp and off-ramp of cryptocurrency facilitated by a crypto conversion app.
What Are Stablecoins?
The concept of a stablecoin is refreshingly simple; it is a type of cryptocurrency token which is pegged to the value of an existing asset.
This is almost always a reserve of fiat money, but it can be assets traded on commodities markets (such as rare metals, fossil fuels, grains, livestock and others) or other cryptocurrencies. The latter allows a stablecoin’s collateral to be managed on the chain itself via smart contracts.
Stablecoins predate the modern cryptocurrency market, with the first successful digital currency, e-gold, being a centralised currency based on gold, silver and other precious metal reserves that could be delivered.
It was very popular in its day, but ran afoul of the law and was effectively shut down around the time Bitcoin and other cryptocurrencies entered the market.
However, the principle of pegging the value of a digital currency to a tangible asset is important for liquidity and versatility purposes, something that is taken to a whole other level with stablecoins.
The most common type of stablecoin, especially since the market contracted in 2022, is stablecoins backed by a financial reserve. They are valuable because each token is backed by a commensurate amount of a backing currency.
For example, if a stablecoin was backed by a Great British pound reserve, it would mean, assuming the token was being managed in good faith, that each crypto pound was backed by a pound coin.
Typically this is proven via a financial audit through a reputable agency, in the same way that any other backed store of value is.
A theoretical concept behind stablecoins, one that is the same as e-gold and other digital gold currencies, is that you could theoretically cash in your crypto pound token for a pound coin since they are meant to have an identical value.
Similarly, other stablecoins can be backed by commodities in the same way with the same promises that one can cash in a commodity-backed stablecoin for the measure of the commodity it represents.
Finally, some stablecoins are backed by other cryptocurrencies, which are technically more complex but are based on the same idea as fiat-based stablecoins.
In practice, stablecoins are often backed by a variety of assets that equal the same market cap, which can include a range of currencies, commodities and crypto.
There are some stablecoins that have historically not been completely backed or proven through independent audits that they are backed with the value claimed, which led to Tether receiving fines from the Commodity Future Trading Commission due to the risk of a run on the coin if everyone tried to withdraw.
Other attempts to create stablecoins using algorithmic price control have been attempted, although these have waned in popularity since the collapse of Terra (LUNA) in 2022.
How Important Are Stablecoins For The Crypto Market?
Liquidity is a vital part of any market, and stable currencies are an essential part of the equation. They provide a stable object of exchange that helps to determine the value of different assets relative to a central point whilst also being more easily transacted.
It is much easier and safer to convert fiat money into a trusted stablecoin than into a more volatile moving target such as Bitcoin or Ether, and conversely, it is easier to take gains in a more volatile token and convert them to a stablecoin whilst diversifying, withdrawing or a combination of the two.