Synopsis: We generally confuse cryptocurrency with stablecoins. This article clears the confusion regarding these two digital assets. It explains advantages and disadvantages of stablecoins. It also mentions how stablecoins lead to liquidity.
Stablecoins are those digital assets that maintain stability in the price levels by being pegged to assets like the US Dollar. Volatility is the main challenge in investing in the crypto market. Stablecoins were created with the intention of getting all the benefits of cryptocurrencies with price stability.
The primary objective is to provide liquidity. Liquidity means the ease at which assets are converted without significant price impact.
Why Stablecoins When Cryptocurrencies Exist?
Cryptocurrencies are extremely volatile in nature. The prices can rise or fall by double-digit, making people vulnerable to unexpected gains and losses.
What Is The Relation Between Stablecoin And Crypto Market?
- When stablecoins are utilised by traders, fresh capital is introduced into the system. If the supply increases to a greater level, then it coincides with bullish sentiment and rising asset prices. The decreasing supply coincides with risk aversion and capital outflows. There is a direct relationship between stablecoin movement and crypto market liquidity.
- Even though stablecoins are well-known for their safety during market stress, stablecoins and money market funds behave differently when there is a capital inflow during the volatility. The top stablecoins will be redeemed, resulting in contraction in the overall market.
How Stablecoins Manage Volatility In The Crypto Market?
- The value of stablecoins is pegged to currencies like the US Dollar. These instruments can also act as a hedge against the extreme volatility in the crypto market.
- They provide liquidity in the crypto market without volatility. Traders and investors can exchange any crypto assets for stablecoins.
- They act as a bridge between traditional finance and crypto. They ensure that traders and investors can get benefits of blockchain technology along with strong control for volatility.
Also Read: Portfolio Allocation: What Percentage of Your Wealth Should Be in Crypto?
Real-World Applications
- Traders utilise stablecoins for both trading and arbitrage opportunities.
- Decentralised finance platforms require stability for lending, borrowing and staking.
- Many use stablecoins for remittance and cross border payments as currencies are prone to inflate or devalue in value.
- The funds can be transferred without high transaction fees and currency conversion costs.
Advantages
- Stablecoins are digital assets which use blockchain technology and offer stability in the market
- They provide similar security and privacy provided in cryptocurrencies. They can also provide additional safety when smart contract technologies are also embedded.
Disadvantages
- Some types of stablecoins are backed by the centrcentralized entities, leading to centralisation and counterparty risks. If these entities are compromised, then the value of these stablecoins will also be affected.
- The regulation about stablecoin is uncertain and evolving. This uncertainty can be misused by perpetrators if they want to commit any fraud.
- These stablecoins are vulnerable to smart contract risk due to potential security breaches and bugs within the contract.
Stablecoins play a crucial role in maintaining crypto market liquidity by providing price stability and acting as a reliable medium of exchange. While they offer significant advantages in reducing volatility and facilitating seamless trading, investors should remain aware of the regulatory uncertainties and centralization risks associated with these digital assets.
Written by Parvati Anilkumar
