Stablecoins vs Bitcoin: What’s the difference?

Posted: 3 November 2021 9:15 am
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Most people have heard about Bitcoin, but they're less familiar with stablecoins. Are they a less risky way to invest in crypto?

Gaining more prominence in Australia over the past few years, stablecoins such as Tether (USDT), Binance USD (BUSD) or Paxos Standard (PAX) are often used as portfolio balancers and safeguards.

So, how do stablecoins compare to Bitcoin?

And how can these cryptocurrencies benefit an investor's portfolio?

A quick look at stablecoins

Stablecoins are cryptocurrencies that are pegged to other assets or benchmarks, such as the US dollar (USD) or gold. This means these currencies are not impacted by price volatility related to cryptocurrencies, and instead follow the movements of fiat economies and markets.

As their name suggests, stablecoins are inherently "stable" and regarded as safe haven assets, making them suitable as a store of value or a transnational currency.

In fact, stablecoins can be used to make payments or trade for other crypto assets at a low cost globally.

Many central banks around the world are investigating the use of government-backed stablecoin versions of their own currencies known as central bank digital currencies (CBDCs).

This could lead to stablecoins being used alongside or in some circumstances replacing traditional currency, to take advantage of the added security and efficiency gained through the use of blockchain technology

[Blockchain: A database where you can add information, but not remove it.]

Beyond traditional payments, stablecoins can also serve as "on and off-ramps" into crypto capital markets, as well as facilitating automated escrow payments through the use of smart contracts.

With the rise of an entire financial system for cryptocurrencies, known as decentralised finance (DeFi), and the increasing adoption rate of digital currencies as legitimate assets, there has been a significant increase in global stablecoin supply.

Stablecoins at a glance

  • As of November 2021, there are over 200 stablecoins in existence
  • The total supply of the stablecoin market has surpassed US$100 billion
  • Stablecoins are emerging as the private sector's answer to central bank digital currencies (CBDCs)
  • They're here to stay, with the likes of Facebook-backed Diem (previously Libra) using these cryptocurrencies to transform payments and other financial services

While there are a few setbacks associated with stablecoins, some experts are confident that they play an important role in the future of both cryptocurrency and finance markets.

Are all stablecoins the same?

No. There are 3 main types of stablecoins – these are defined by their underlying collateral structure, which is another way of saying "what they are backed by". Here are some examples below:

1) Fiat-collateralised

These are simple stablecoins that mimic fiat currency such as the US dollar or the euro. Most fiat-collateralised stablecoins are backed at a 1:1 ratio, which means that for each stablecoin there is a fiat currency in a bank account.

During times of volatility, many investors will choose to park their profits in stablecoins to retain as much profit as possible, while reducing risk of loss if the crypto market dips significantly or unexpectedly.

Some examples of fiat-collateralised stablecoins are Tether (USDT) or USD Coin (USDC).

2) Crypto-collateralised

This version uses other cryptocurrencies such as Ethereum, as collateral for the stablecoins. By doing so, these stablecoins are much more decentralised than fiat-collateralised stablecoins, as everything is conducted on the blockchain.

To help reduce price volatility risks, crypto-collateralised stablecoins are often over-collateralised in order to absorb price fluctuations in the collateral.

Well-known crypto-collateriased stablecoins include MakerDAO's Dai (DAI).

3) Commodity-collateralised

These stablecoins are backed by stable assets and commodities such as precious metals, oil or real estate. Commodity-collateralised stablecoins are often more exposed to price movements. However, since commodities increase in value over the long term, investors tend to buy and hold this asset for capital appreciation.

Examples of commodity-collateralised stablecoins encompass the likes of Gold Standard (AUS) and Silver Standard (AGS) available on CoinSpot.

How do stablecoins compare to Bitcoin?

When comparing stablecoins to Bitcoin, it's important to realise that they both serve different purposes.

Bitcoin has historically been seen as an investment and/or store of value. It typically leverages a peer-to-peer payment system, which can be used to make cross-border payments within a matter of seconds or minutes.

In contrast, stablecoins are paired 1:1 with fiat currencies, which means they aren't necessarily viewed as an investment. Instead, stablecoins' utility is likened more to a hedge against market volatility or a safeguard when moving between positions.

The wide adoption of stablecoins is a clear indicator of their growing popularity and potential to continue to exist as integral components of the cryptocurrency ecosystem in the future, alongside crypto pillars such as Bitcoin.

Ray Brown is a market analyst at CoinSpot, a platform that allows Aussies to buy, sell, swap and trade over 300+ cryptocurrencies. Since inception, CoinSpot has helped over 2 million customers buy and invest in cryptocurrency.

Disclaimer: The views and opinions expressed in this article (which may be subject to change without notice) are solely those of the author and do not necessarily reflect those of Finder and its employees. The information contained in this article is not intended to be and does not constitute financial advice, investment advice, trading advice or any other advice or recommendation of any sort. Neither the author nor Finder has taken into account your personal circumstances. You should seek professional advice before making any further decisions based on this information.

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