Stablecoin is considered one of the technical foundations of DeFi, making it easy to exchange different assets. Volatile cryptocurrencies can be exchanged for each other through stablecoins. Therefore, stablecoins act as a unit of account to some extent.
What are stablecoins?
A stablecoin is a cryptocurrency with a fixed price, which is often pegged to a real-world fiat currency. Take USDT, the most widely used stablecoin currently, for example, USDT is pegged to the US dollar, where 1 USDT = 1 US dollar.
From a total market cap of less than $500 million in 2017 to $100 billion today, stablecoins have certainly become an essential part of the crypto world, representing two of the top five cryptocurrencies by market cap.
Creating a stablecoin
Virtual currencies were created with the aim of replacing traditional currencies and challenging the centralized financial system. However, it was found that mainstream crypto assets, including Bitcoin and Ethereum, are too volatile to completely replace fiat currencies as a means of global exchange, making them more of speculative assets. At that time, transactions between cryptocurrencies either followed the primitive rule of 'barter' or had to be exchanged through fiat currencies.
In order to facilitate transactions between cryptocurrencies and find a common unit of account for most crypto assets, it is essential to innovate tokens with more stable value. This is why stablecoins emerged. The first issuance in history is USDT, which was issued by Tether Limited in 2014.
Stablecoin function
Stablecoin is considered one of the technical foundations of DeFi, making it easy to exchange different assets. Volatile cryptocurrencies can be exchanged for each other through stablecoins. Therefore, stablecoins act as a unit of account to some extent.
Also, traders can convert their risky digital assets into stablecoins during bear markets to manage risk without leaving the cryptocurrency ecosystem.
The bridge between blockchain and the real world
Stablecoin has expanded the limits of fiat currency and is a bridge between blockchain and the real world. As a means of payment, stablecoin prices are more stable than other digital assets, thus functioning more like fiat money.
Although stablecoins, by definition, should be able to maintain price stability, there is still a possibility of 'instability.'
For off-chain backed stablecoins, even if there are enough fiat assets as collateral, this does not mean that the price will always remain tied to the fiat currency. There will be both negative and positive premiums as demand for stablecoins fluctuates continuously. It is also uncertain whether the collateralized stablecoin has sufficient resilience to withstand harsh market conditions.
Again taking USDT as an example, a large number of investors chose to exit the market by selling USDT during the extreme event that occurred on May 12, 2021, which caused USDT to rise against the US dollar by about 2%. Additionally, a lack of investor trust in the issuer may also lead to bank runs.