Hey there mate! How are you doing? Well, I missed you and couldn’t wait to write you again haha.
Today, we’ll talk about the second part of our previous article (DeFi)- ‘Stable Coins’. I promise you mate, this is going to be a very short read. We’re just going through the meaning of stable coins and why are they important to DeFi.
Before that, let me give you a very vital information real quick!
cryptocurrencies not only serve as a store of value, but also as a means of transactions. This is good but one major issue is the erratic nature of these currencies. Bitcoin is the most popular digital currency in use today but it’s unpredictability is dangerous to everyday users. As a result of it’s volatile nature, people cannot know what the value of their money will be in the following week. I want to be able to know what the value of my funds will be too. One thing you must know is that this so called volatile nature of these currencies, are not controlled by man. They are not controlled by any organisation either. So what determines the rise and fall in the prices of these currencies? Good question!
When I first heard of cryptocurrencies, I was worried because how can $50million turn to $10million in a twinkle of an eye. Jeez! It didn’t just make any sense. This made me pessimistic but then I came to know that they aren’t controlled by humans but a number of unseen factors are responsible for this.
If you’re familiar with economics, you’ll know that the higher the demand is for a particular product, the higher the value of that product. Demand and supply is a major factor that affects the prices of cryptocurrencies. If you can recall from our previous articles, we said that for any commodity to be considered as money, it must be generally acceptable by the community. This point explains everything. The value of a thing depends on how much worth people place on it. If there is no demand for bitcoin, the price falls; and vice versa.
Another important factor to note is, Government regulations. You may be wandering how government regulations can affect the price of cryptocurrencies; after-all they are decentralised and not controlled by anyone. Good thinking! But remember you’re in a country ruled by them. Government can place bans on the use of cryptocurrencies. Yeah! They can do that. For instance, in Nigeria, the government placed ban on the central Bank for transactions using cryptocurrencies. Although these regulations doesn’t take cryptocurrencies away, but prices can be affected. Taking us back to our law of demand and supply. If the government bans the use of these currencies, then demand for it reduces which causes the value to drop. And vice versa.
Things like demand and supply, government regulations, competitions from other coins also affect the price of cryptocurrencies. This is not so good for big time investors or is it? They wouldn’t be able to predict the value of their money in the following week. No one knows when the value of a coin will drop. This is a bit dangerous and that is the sole aim of stable coins- stability in the price of currencies.
Just like the meaning of the word ‘stable’, stable coins are simply cryptocurrencies that have a relatively stagnant value. How possible is that? Very possible mate! Sit tight, this is just getting interesting. The idea around stable coin is to achieve both the characteristics of cryptocurrencies which is decentralisation and at the same time, achieve the characteristics of fiat currencies which is stability. In achieving this, stable coins are pegged to fiat currencies like dollars, so that their value stays intact as long as the value of dollars stays intact too.
People can’t use bitcoin for day to day transactions; well, like we said earlier, due to it’s volatility. People can’t use stable coins for day to day activities for now because they are not so popular yet. So stable coins like USDT (tether) are mostly used for cryptocurrency transactions. Some popular examples of stable coins include; Tether (USDT), Dai (DAI), USD coin (USDC), TrueUSD (TUSD), to mention but a few.
I wanna ask you one question yeah? If stable coins are pegged to fiat currencies doesn’t that make it risky? What if the value of the fiat currency depreciates? Does it also affect the coin? Well mate, yes! Yes it does. Stable coins are subject to the same volatility and risk associated with the backing asset. If backed in a decentralised manner, then they are relatively safe but if backed in a centralised manner, they may be robbed, or suffer loss of confidence.
A little lost? Don’t worry I got you! In order for stable coins to achieve the characteristics of ‘stability’, they have to be equal to a fiat currency. That means, 1USDT must be equivalent to $1. but doesn’t that make is risky too? Yes it does, but the $ currency is strong, and has attained a reasonable level of stability over the years.
Another point there is the fact that stable coins mustn’t be pegged to only fiat currencies. They can be pegged to other assests which has high stability power such as gold or real estate, it can also be pegged to other cryptocurrencies, it can equally be pegged to an algorithm. All these are the different types of stable coins, and the main idea is to attain a certain level of stability for ease of transactions.
HOW DOES THIS RELATE TO DeFi?
Last week, we talked about the DeFi. If you recall, we said that Decentralised Finance are financial services with no central authority. It is not controlled by one but by all. From the word ‘decentralised’, the monetary value for such services has to be decentralised too. That brought us to stable coins because in order to build reliable financial services, DeFi uses stable currencies.
I promised that this would be a short read, so I’ll stop here. In a couple of more articles to come, I’ll talk about one of my favourite DeFi projects called ‘LIQWID’.
I’ll see you next Thursday where we will explore the world of the second generation of blockchain- Ethereum.
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See you next Thursday!