The state of cross-border payments is changing quickly, and digital currency exchanges are becoming increasingly feasible. However, one major obstacle still stands: the stability of well-known cryptocurrencies. Due to the large price swings brought about by the speculative trading of assets like Bitcoin and Ethereum, conventional businesses are beginning to have doubts about blockchain-based payment solutions.
The fact that these cryptocurrencies are not tied to the US dollar is a significant problem. Stablecoins, which are blockchain-based currencies with a one-to-one ratio to the US dollar and are usually backed by cash reserves or investment-grade securities, are helpful in this situation.
What is stablecoin?
Cryptocurrencies known as stablecoins have a fixed value in relation to other money, commodities, or financial instruments. This method makes stablecoins more appropriate for regular transactions by offering an alternative to the extreme volatility observed in well-known cryptocurrencies like Bitcoin (BTC).
Reserve assets can support stablecoins through algorithmic processes, fiat currencies (like the US dollar), commodities (like gold), or both. Stablecoins, which provide price stability in contrast to traditional cryptocurrencies, are becoming increasingly popular in the fintech industry.
Understanding stablecoin structures
Three general categories of structures exist:
Fiat-collateralized stablecoins
Fiat-collateralized stablecoins, often regarded as the most efficient structure, are supported by reserves of fiat money kept in bank accounts. Every stablecoin created is backed by an equivalent amount of fiat money to preserve financial stability.
Crypto-collateralized stablecoins
Reserves of other cryptocurrencies support stablecoins that have been cryptocurrency-collateralized. Stablecoins are backed by a reserve of different cryptocurrencies, typically more volatile and well-known ones like Ethereum or Bitcoin. They are fixed to a particular value, like the US dollar. To guarantee the stability of the stablecoin's value in this instance, a reserve asset serves as collateral.
Algorithmic coins
Stablecoins employ algorithms to dynamically modify their currency supply in accordance with market demand, with the goal of preserving a consistent value in the absence of collateral. This implies that an algorithmic stablecoin has additional risk because it depends on independent investors.
Uses of Stablecoins:
In the Web3 ecosystem and the cryptocurrency space, stablecoins are essential because they boost trade volume and economic activity. They have an advantage over conventional currencies because they transfer value utilizing blockchains instead of antiquated manual procedures. With centralized stablecoins, fiat-pegged value may be transferred globally between wallets without the use of intermediaries.
Stablecoins also function as collateral in DeFi and non-custodial savings accounts for individual users, enabling them to earn returns and engage in yield farming techniques. Fintech use cases for stablecoins:
- Stablecoins have transformed international payments and remittances by increasing their speed, affordability, and accessibility. Stablecoins provide almost instantaneous transactions with low fees, in contrast to typical remittance systems like Western Union, which have exorbitant fees and sometimes take days.
- Stablecoins are essential for lending, borrowing, and trading in the context of decentralized finance (DeFi). In the frequently unstable cryptocurrency ecosystem, they act as a reliable medium of trade or store of value.
- Thanks to the rise of sites that provide interest-bearing stablecoin accounts, users can now earn rates that are higher than those found in conventional savings accounts.
- Stablecoins allow retailers to accept cryptocurrencies in digital commerce without worrying about price volatility. They're used for payments in e-commerce.
Fintechs are meeting in the middle: Future of Payments with Stablecoins
Although the advantages of stablecoins and blockchains for payments are apparent, their full effects will only be felt once they are employed more extensively. As of now, network effects are not active. In 2024, not every company will be able to accept or transmit stablecoins. Global trade is still powered by fiat currency and systems.
Therefore, connecting banks and blockchains can provide new value. As the crypto industry develops and regulations offer more clarity, businesses will find it more desirable to switch between fiat and digital currencies. A new ecosystem of fintech companies will emerge that uses stablecoin as the underlying settlement network and combines blockchain technology with local real-time banking networks.
Every bank and fintech will eventually have some stablecoin functionality. Stablecoin technology is supporting the launch of stablecoin wallets for fintech companies like Freemarket, enabling its users to transfer money immediately and view both a stablecoin and fiat balance. We are also assisting payment providers such as dLocal in sending their merchants to other marketplaces with same-day payouts.
Factors Stablecoin Development Demand:
1. Stability of Prices and Risk Reduction
Stablecoins are becoming increasingly popular due to their capacity to reduce risk and offer price stability. Conventional cryptocurrencies are not suited for daily transactions or as a store of value because of their significant price swings. A more reliable option is stablecoins, which guarantee that the value of the digital asset stays consistent primarily and reflects the value of the pegged item.
2. Crypto-to-Fiat Onboarding
Services for stablecoin help in creating a smooth transition between the realm of cryptocurrencies and the established financial system. With stablecoins, users can quickly transfer money between cryptocurrency exchanges and traditional banks without having to go through laborious conversion procedures. Additionally, they offer a way for fiat money to be represented on the blockchain. Stablecoins are now the go-to option for anyone who wishes to trade cryptocurrencies without being totally exposed to their volatility because of this attribute.
3. Quicker and less expensive transactions
Stablecoins have far lower transaction fees and quicker settlement times than traditional banking systems. When made between countries or people, stablecoin transfers are faster and less expensive than standard remittance services. As a result, stablecoins have become widely used in international trade, remittances, and cross-border payments.
4. Decentralized Finance, or DeFi Adoption
The field of decentralized finance, or DeFi, has multiplied in the last several years. Because stablecoin development makes lending, borrowing, and yield farming on DeFi platforms easier, it plays a crucial role in this ecosystem. Users can obtain loans without traditional credit checks by utilizing stable coins as collateral, thus increasing financial inclusion and capital access.
5. Trading and Arbitrage of Cryptocurrencies
Stablecoins have emerged as crucial instruments for traders and arbitrageurs. Traders can protect their money during market downturns by changing volatile cryptocurrencies into stablecoins, which allows them to reenter the market once it has stabilized. Additionally, stablecoins increase market efficiency by opening up opportunities for arbitrage across many exchanges with disparate prices.
6. Guarding Against Volatility in the Market
Investors in cryptocurrencies frequently seek strategies to protect themselves from the market's volatility. Stablecoins, while retaining liquidity, provide an easy way to park money during erratic market conditions. When they expect favorable conditions, traders can immediately change their holdings into stable currency and rejoin the market.
7. Security and Privacy
Stablecoin development services take care to provide improved security and privacy while creating stablecoins on blockchains with a privacy focus. An additional degree of protection against fraud and identity theft is provided by the ability of users to complete transactions without disclosing personal information. Individuals who respect privacy in their financial dealings have been drawn to this anonymity.
8. Automated Smart Contracts
Smart contract features are frequently included in stablecoin development services. Smart contracts allow businesses to automate and transparently negotiate financial terms, which streamlines operations and lowers administrative costs.
9. Tokenization and Fundraising
Stablecoins provide a stable and safe way to raise money via security token offerings (STOs) and initial coin offerings (ICOs). Tokenizing assets such as stocks, commodities, or real estate allows businesses to offer fractional ownership and liquidity.
Risks Associated with Stablecoins
- Varying stablecoin designs come with varying dangers attached. These could consist of:
- Depegging risk: The stablecoin may deviate from its aim if the underlying economic or algorithmic procedures fail due to liquidity shocks, "bank run" scenarios, poor reserve management, and other reasons.
- Regulatory risk: Depending on the location, local financial organizations may regulate stablecoins differently.
- Centralization risk: Tokens at particular wallet addresses may be frozen by certain centralized stablecoin issuers.
- Key management risk: Users are solely responsible for safely keeping their private keys if they store stablecoins in a non-custodial wallet.
Stablecoins vs. central bank digital currencies (CBDCs)
Central bank digital currencies (CBDCs), another innovation serving a similar purpose, are frequently brought up in discussions concerning stablecoins. What then separates the two?
While CBDCs are issued by central banks, stablecoins are digital assets that private enterprises like Ripple issue. CBDCs' principal goals are to digitize a nation's fiat money and enable more effective transactions for its populace. By immediately integrating digital assets into monetary policy and leveraging public confidence in government agencies, they increase the transparency of central banks' decision-making.
According to research from the Atlantic Council, over 100 countries are presently investigating, creating, or introducing CBDCs. Even though these currencies might improve home payment systems, issues with interoperability and their suitability for cross-border transactions still exist.
Future of Stablecoins in FinTech
Stablecoins are expected to impact financial services as fintech expands significantly. They offer a quick, precise, and safe method of processing payments—especially in today's world, where digital is everything. The difference between stablecoins and conventional currencies may become even more hazy as central banks explore central bank digital currencies (CBDCs).
Also, stablecoins are expected to be used more widely in the upcoming years as more fintech platforms use them to provide quicker, less expensive, and more accessible financial services. Governments will probably enact more precise laws to guarantee stablecoins' dependability and safety, which will support the preservation of financial stability. Stablecoins also promote innovation and interoperability by linking existing economic systems and decentralized finance (DeFi).
Conclusion
Although stablecoins appear simple, they are among the most significant developments in the cryptocurrency world because they allow for the smooth transfer of constant value. While stablecoin designs vary widely, all stablecoin protocols share the same fundamental information about the asset they are tied to. The tried-and-true data infrastructure offered by Chainlink contributes to the stability of the broader DeFi ecosystem as well as the dependability, security, and transparency of stablecoins.