What Is a Stablecoin? And What Is Its Purpose?

One of the common questions I hear from retirees new to the crypto world is, “What is a stablecoin?”

That’s usually followed by “What does it do?” or “What’s its purpose?”

This article answers those questions.

What a Stablecoin Is

A stablecoin is a cryptocurrency whose price is pegged, that is, its price is “attached” to another asset’s price. Most common is a peg to the U.S. dollar, which means that one stable coin is worth $1 USD.

The price isn’t always $1 though. A USD stablecoin’s price will usually range from half a cent below $1 to half a cent above it. So at any given point in time, it could be priced at somewhere between 99.5 cents and 100.5 cents.

That tight range is why they’re called stablecoins.

There are two types of stablecoins.

The Purpose of Stablecoins

Stablecoins became popular as a way to park funds on a crypto exchange. If I had half a Bitcoin that I bought at a price of $20,000 USD, I could wait until its price doubled, then trade my $20,000 of BTC into a stablecoin to realize a $10,000 gain.

I would then be holding $20,000 USDC, for example, on the same exchange. I would hold those stablecoins while I looked for another opportunity to invest those funds.

I might wait until BTC dropped to $30,000 and then buy it again, with the expectation that it would return to $40,000, or go even higher.

Due to the low volatility of stablecoins, I wouldn’t have to worry about losing any of $20,000.

With the rise of rewards platforms, which pay interest for crypto assets parked on them, some people now own stablecoins for the sole purpose of earning high rates of interest.

Without the risk of losing purchasing power due to price volatility, these people are earning significantly more than they would by holding USD (for example) in a bank’s savings account.

Backed and Unbacked Stablecoins

Backed stablecoins are those pegged to an asset. They could be backed to fiat money, to a physical asset (such as gold), or to another cryptocurrency (or a basket of them).

Unbacked stablecoins are uncommon these days. These platforms use algorithms (mathematical formulas) to control the supply of the stablecoin, and thus the price.

The rest of this article will focus on backed “stables,” as they’re often called.

Types of Backing

As I mentioned earlier, stables can be backed by fiat money, by physical assets, or by a cryptocurrency.

Backed by Fiat Money

A currency backs this type of stablecoin. By far the most common backing is the U.S. dollar.

For each stable that exists, $1 USD is held in escrow at a regulated financial institution in the U.S.

Other currencies that back stables are the euro, the yen, the British pound, the Swiss franc, the Canadian dollar, and the Hong Kong dollar.

The most commonly traded USD stables are:

• USDT (known as Tether, issued by Tether Limited, which is controlled by Bitfinex)
• USDC (USD Coin, issued by the Circle consortium)
• GUSD (Gemini USD, issued by the Gemini exchange)
• BUSD (Binance USD, issued by the Binance exchange)
• TUSD (TrueUSD, issued by TrustToken)

USDT (Tether)

USDC (USD Coin)

GUSD (Gemini USD)

BUSD (Binance USD)

US Terra (UST)

UST (TerraUSD)

The new kid on the block is UST (US Terra), a stablecoin issued on the LUNA platform, which is built on the Terra decentralized finance (DeFi) blockchain.

Terra’s exciting goal is to make stablecoins available for dozens of the world’s currencies.

If it accomplishes its goal, you and I could have a digital wallet on our phone with, for example, $5,000 of UST.

If we travel to France, we can make purchases with our UST at a better exchange rate than we would receive on a foreign exchange market, or from a currency exchange business at the airport.

The business owner will pay lower fees to convert our UST to Euro, making it a win-win for each of us.

The best part is that we could then travel to the United Kingdom and pay for things there without having to worry about being gouged on the exchange rate.

James Altucher, the editor of Altucher’s Early-Stage Crypto Investor, thinks Terra could become the world’s foreign exchange market, all based on stablecoins.

This could allow expats who remit money to their home countries to save hundreds of millions of dollars in fees every year.

Asset-Backed

PAXG (Pax Gold)

The second type of backed stablecoin is the asset-backed type. The price of these stablecoins isn’t stable in terms of any fiat currency.

Its value comes from being tied one to one to a commodity of some type. The most commonly used one is gold.

PAXG (Paxos Gold), for example, has a price tied to the price of one troy ounce of gold. Others have a price tied to the price of a gram of gold.

The peg to the ounce or gram never changes. However, as the price of gold rises and falls, the price of this type of stablecoin rises and falls with it.

The creators of this type of coin keep an amount of gold on hand, stored in vaults around the world, that equals the total amount of gold that all the coins represent.

PAXG is stored in Brinks vaults.

Cryptocurrency-Backed

DAI

The third type of backed stablecoin is one backed by other cryptocurrencies. DAI is the most common of this type, with a market cap of over $9 billion USD.

DAI trades in an even tighter range that fiat-based stables. It rarely goes beyond 1/10^th of a cent in either direction.

This backing, or collateralization, is performed by using smart contracts. The coin’s supply is also regulated by smart contracts.

The Value of Stablecoins If You’re on a Fixed Income

Currently, you can earn close to or above the U.S. inflation rate of 7.9% (at the end of March 2022).

Celsius Network is a popular rewards platform that I use. It pays 7.1% APY for the most popular stablecoins. Compare that to a savings account, which pays 0.1% or less.

That’s a 71X increase in interest, or more, depending on the rate you receive from your bank.

If you live outside the U.S., or are an accredited investor in the U.S., you can receive up to 9.32% if you earn the interest in CEL tokens.

CEL tokens fluctuate in price, so you may prefer to take the lower interest rate and have it paid in-kind for each stablecoin you hold.

You can learn more about Celsius Network here.

So, What Is a Stablecoin for You, a Retiree?

For you and me, stablecoins are a no muss, no fuss way to enter the world of crypto.

Stablecoins are also a way to maintain our retirement lifestyle. They let us earn much higher interest rates on our savings without having to worry about our savings dropping in value.

If you’re not yet retired, you can start accumulating more money now so that you have more to spend during retirement. Or use the extra to retire earlier than you might have planned.