The buzz around stablecoins remains high, years after their inception. These digital assets have seen tremendous growth compared to many cryptocurrencies in the market. According to reports, the supply of stablecoins had grown to 6 billion over the last five years. Just recently, in a span of four months, the number doubled up to 12 billion, indicating how much these assets are gaining popularity.
Since the start of 2021, the stablecoin market has grown to around $40 billion while monthly transactions exceeded $200 billion in January. So what is causing the increased traction of stablecoins in the market?
Using Stablecoins to Mitigate Risks
Stablecoins are becoming more popular due to their ability to reduce the risks associated with the volatile nature of the cryptocurrency market. Investors are more willing to invest in these assets since they pose fewer risks compared to many other digital assets in the market.
Notably, cryptocurrencies were initially not convenient for use in transactions due to their high rate of volatility as prices could change within a few hours. The high rate of price fluctuation made cryptocurrencies unsuitable for use in investment and transactions. By introducing stablecoins, developers helped users and investors control or ground the value associated with the assets. In turn, this allowed many investors to have confidence in the assets as a doorway into the cryptocurrency market.
The Growth of DeFi
Notably, stablecoins allow investors to generate yield on their assets within the DeFi market. in recent days, DeFi has fueled the growth in the use of stablecoins by opening up other use cases within its ecosystem. In addition, the growth in yields from DeFi investments has also led to increased stablecoin usage.
Stablecoins are also used in liquidity pools where users deposit their tokens and lock them up by a smart contract. Users are incentivized to deposit their assets into these pools by earning a portion of the trading fees obtained from the pairs in that liquidity pool.
They are Backed By a Commodity
Stablecoins are usually backed by a physical commodity like gold which makes them have the same stability as fiat currencies. Investors using stablecoins can therefore monitor the value of the underlying commodity to understand the value of the stablecoin.
Stablecoins have reserves that back them up and help to maintain price stability. This has contributed to increased investors’ confidence as well as the use of stablecoins in transactions. Additionally, the prices of the commodities are regulated by controlling authorities that take timely measures to maintain price stability.
In addition to commodities like gold or silver, some stablecoins are backed by a fiat currency like the dollar as collateral for the number of cryptos issued while others are backed by other digital currencies like Bitcoin although this may expose them to even more volatility.
Algorithmic Stablecoins
Algorithmic or non-collateralized are not backed by reserve asset or currency but instead uses mechanisms similar to those used by the central bank to maintain price stability in the traditional financial industry.
While stablecoins may not be perfect, they have managed to offer a viable alternative to highly volatile cryptocurrencies. Currently, stablecoins are used in business-to-customer (B2C), business-to-business (B2B), and peer-to-peer transactions (P2P).