Stablecoins, Coins, and Tokens Explained

In this lesson you will learn about Stablecoins, coins, and tokens. At the end of the lesson you will know about the differences between the three digital assets and a few of its examples.
July 1, 2022

Stablecoins, Coins, and Tokens Explained

The cryptocurrency market has grown at a phenomenal rate over the past year. But unfortunately, as more people learn about blockchain and cryptocurrencies, it's becoming increasingly difficult to understand it all.

These new Blockchain terms can be pretty confusing, sometimes leaving you with more questions than answers. This article will help clarify some confusion by explaining stablecoins, coins, and tokens.

In this lesson you will learn about Stablecoins, coins, and tokens. At the end of the lesson you will know about the differences between the three digital assets and a few of its examples.

What are Stablecoins?

A stablecoin describes a cryptocurrency pegged to another stable asset or basket of assets: a fiat currency or a precious metal (e.g., gold).

Unlike traditional cryptocurrencies, stablecoins are more practical because they can maintain a stable price level. Investors are inclined towards this currency because it's hard to find any pumps or crashes with stablecoins, meaning they can be used as an alternative currency in areas where hyperinflation makes local currencies unstable or unusable without high fees.

As an example, Tether, the most valuable stablecoin, is backed by US dollars, with each USD-Tether pair being worth $1. So, if a buyer wants to purchase something for $1 using Bitcoin, they would first need to trade Bitcoin for USD-Tether coins and then use the USD-Tether coins to buy the product.

Stablecoins categorize into fiat-collateralized stablecoins and non-collateralized stablecoins and include popular offerings like Tether (USDT), USD Coin (USDC), DAI, TerraUSD (TUSD), and Binance USD (BUSD).

How does Stablecoins Work?

While stablecoins fit more the description of money than traditional cryptocurrencies, they can operate differently.

Tether, for example, pegs its currency according to many different collaterals. According to a document disclosed by the company, less than 3% of Tether's underlying assets are cash. Instead, the majority peg mixes financial instruments, loans, precious metals, and even some other digital tokens.

The other top stablecoin, USDC, takes a different route - it's a reserve-backed asset managed by Circle, a Boston-based crypto payments company. But, again, being a centralized USD-pegged coin makes it one of the most reliable stablecoin on the market.

Stablecoins Benefits

Stability

Cryptocurrencies are still new and relatively unknown, so people don't have faith in their long-term future - but by pegging their value to fiat currency or other digital assets, Stablecoins can solve a colossal stability problem. Moreover, their approach makes them far more likely to be accepted by retailers and other traditional institutions.

Investment-friendly

Since Stablecoins are backed by fixed assets - making investments into these assets can be considered a safe investment because you can save on fees and maintain the value of your crypto during volatile trading periods.

Most beginners use them for less-advanced investments, such as staking and lending. But some people also use them for more advanced purposes like trades that require quick turnarounds.

Stablecoins Risks

Counterparty Risk

If there is a financial crisis or a global recession, what happens is credit will dry up, and there will be massive liquidity issues. Where will stablecoins like Tether and USDC, which hold significant percentages of their reserves on commercial papers by unknown entities, stand in such an event?

Brexit showed everyone how the pound struggled to maintain its peg with the Euro mechanism regardless of being one of the biggest economies in the world. It's hard to believe corporations will be more disciplined in maintaining their pegs than governments.

Another problem is since stablecoins are used for crypto trading - when they collapse, there could be a panic that could impact the value of both Bitcoin and Ethereum.

Centralization Risk

In addition to being prone to destabilization from external factors, Fiat-Collateralized Stablecoins are often criticized because of their centralized nature. If a company owns many desired assets, it can manipulate the stablecoin's price and policies.

What are Coins?

Coins are a digital or virtual currency designed to work as a medium of exchange. They use cryptography to secure and verify transactions and control the creation of new units. These coins are different from a traditional currency because they don't rely on central banks or governments for coin supply. They have become an attractive commodity because they are decentralized and unregulated hence don't rely on banks, governments, or any other single entity for coin supply.

In other words, coins rely on peer-to-peer networking and participants' consensus - meaning coins can be purchased and stored on cryptographic wallets for use for various purposes, including but not limited to investing and trading.

Types of coins include Bitcoin and Altcoins, i.e., cryptocurrencies other than Bitcoin, created to improve some aspect of BTC like transaction speeds or serve a different need. Examples of Altcoins include stablecoins, staking-based coins, and governance tokens.

How do Coins Work?

Users can transfer digital payments from their wallet to someone else's by using a private key - with digital transactions for cryptocurrencies recorded and stored permanently in a ledger as there is an existence of blockchain.

Mathematical proofs are used to secure the blockchain, which helps confirm all these transactions.

Coins Benefits

Better Alternatives

There is a wide range of altcoins with different purposes and competitive advantages, making it easier for investors to find the right option. A variety of options also helps improve the quality of offerings in the coin market.

For example:

Privacy-focused coins like Monero can protect sensitive information from being revealed in data breaches or theft incidents.

Coin Risks

There is a significant risk associated with investing in altcoins, as many could be scams. Furthermore, even with meticulous research, the project could still fail.

Another issue is that, unlike Bitcoin, most Altcoins lack exposure and real-world applications, which affects their value and lessens their potential for user adoption. Moreover, the prices can be volatile, meaning they can change at an astonishing rate.

What are Tokens?

Tokens represent a unit of value or utility in an economy. For example, the company can issue tokens by purchasing products and services in their ecosystem or issuing voting tokens meant to give investors a voice and voting power on how the company is managed. Tokens are in some instances seen as an alternative to traditional shares. Startups can bypass the complicated process of raising money from venture capitalists or banks by issuing their tokens instead.

Crypto tokens have become increasingly popular with startups looking for funding from outside sources like ICOs. There are many different classifications for crypto tokens, but they all create a sense of ownership and belonging in communities.

How do Tokens Work?

Crypto tokens are cryptocurrencies created to power decentralized applications. Tokens describe an asset, identity, stake, or even currency. Unlike traditional cryptocurrencies like bitcoin and Ethereum, crypto tokens can represent anything from a digital work of art to shares in a company.

Token Benefits

Better Access to Funding

Tokens are becoming increasingly popular in the crypto space because they offer a way for startups to raise funds without going through any strict regulatory process. They are also faster and cheaper than traditional fundraising methods.

Better Liquidity

They're easy enough for individuals to invest in but have enough complexity to interest institutions. Tokens are also more liquid than cryptocurrencies like Bitcoin or Ethereum because they are easier to buy or sell on exchanges.

Token Risks

Manipulation Risks

Tokens can be particularly vulnerable to social engineering and misinformation risks. In addition, cyber extortionists and criminals can easily prey on investors who peddle "shiny object" projects designed to separate investors from their money.

Lack of Regulation

One of the significant risks with crypto tokens is no coordination and clarity on regulatory, financial, tax, and legal treatment. Considering how new this market is - it could take a long time for regulations to catch up.

Lesson Summary

  • A stablecoin describes a cryptocurrency pegged to another stable asset or basket of assets, a fiat currency or a precious metal (e.g., gold). Stablecoins differ from normal cryptocurrencies because they're designed to maintain a stable price level over time.
  • Coins are a digital or virtual currency designed to work as a medium of exchange. They use cryptography to secure and verify transactions and control the creation of new units. Types of coins include Bitcoin and Altcoins.
  • Tokens represent a unit of value or utility in an economy and power decentralized applications.
Resources
  1. Report on Stablecoins - Treasury Department - https://home.treasury.gov/system/files/136/StableCoinReport_Nov1_508.pdf
  2. Stablecoins: risks, potential, and regulation - https://www.bis.org/publ/work905.pdf
  3. Crypto Encyclopedia. Coins, Tokens and Digital Assets from A to Z - https://www.heg-fr.ch/media/lbdfnyd1/schueffelgroenewegbaldegger2019_crypto-encyclopedia_eng.pdf

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