What are Stablecoins? A Guide for Canadians
Stablecoins aim to offer all the benefits of cryptocurrencies while attempting to avoid rampant volatility. In this article, we explain how they try to achieve that goal.
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What are stablecoins?
Stablecoins are cryptocurrencies that are directly pegged to another asset, most commonly a fiat currency such as USD or a commodity such as gold or real estate. As the name suggests, stablecoins aim to bridge the gap between cryptocurrencies’ benefits and the stable nature offered by fiat currencies. In other words, they aim to offer all the benefits of cryptocurrencies while attempting to avoid rampant volatility, which has made crypto investments less suitable for common transactions.
How do stablecoins work?
Stablecoins may be pegged to a currency like the U.S. dollar or to the price of a commodity such as gold or use an algorithm to control supply. Stablecoins also maintain reserve assets as collateral or through algorithmic formulas that are supposed to control supply. This way, even if the value of Bitcoin or other cryptocurrencies fluctuates significantly, stablecoins will maintain their relative price stability. A stablecoin's pegged value is what makes it useful within the world of crypto.
Different types of stablecoins
Fiat-collateralized / Fiat-backed stablecoins
Fiat-collateralized stablecoins use fiat currency issued by a financial institution such as a bank as collateral to issue stablecoins. In this case, stablecoins are backed 1:1 by fiat currency like the USD or CAD. For every token in circulation, fiat-backed stablecoins often have one dollar in reserve in cash or cash equivalents. The reserves of these stablecoins require to be regularly audited and managed by independent trustees to ensure compliance.
Crypto-collateralized stablecoins are backed by other cryptocurrencies. They work similarly to a fiat-collateralized stablecoin; however, cryptocurrency is used as collateral instead of fiat currency. For example, Bitcoin or Ethereum can be kept as collateral to create a crypto-collateralized stablecoin.
Because the reserve cryptocurrency may also be prone to high volatility, such stablecoins are overcollateralized. This means that the value of cryptocurrency held in reserves exceeds the value of the stablecoins issued. For example, if a crypto-collateralized stablecoin is pegged to the US dollar, it can be something around a $2 peg for each $1 coin issued.
Algorithmic stablecoins have no reserves, neither fiat nor crypto. Instead, a functional mechanism is put in place to make the production of stablecoins follow the demand, thus keeping the price stable. This mechanism is equivalent to how central banks operate when they produce fiat.
Commodity-backed stablecoins are backed by reserves of physical assets like precious metals, oil and real estate. Gold is one of the most common commodities to be collateralized. However, these commodities are prone to price fluctuations, which may result in a loss of value.
The benefits of stablecoins
There are many benefits to buying stablecoins. Here are some to consider.
The obvious benefit of stablecoins is that they are based on blockchain technology. They operate in identical ways to traditional cryptocurrencies, which means that international transactions are much faster and cheaper than with fiat currencies.
Due to the nature of stablecoins being pegged to a fiat currency or commodity, they typically experience little to no high volatility trading periods, which results in a more reliable currency with the benefits of blockchain technology.
Reliable medium of exchange
Stablecoins are used to power many exchanges and applications as they bridge the gap between different currencies. They can be used for connecting different blockchain ecosystems to facilitate payments or utility.
Increasing user participation blockchain networks
By allowing a risk-free exchange of assets and connecting a range of DeFi applications and services, stablecoins reduce barriers for users around the world to buy and sell cryptocurrencies and use blockchain-enabled services.
How to buy stablecoins in Canada?
Using a cryptocurrency exchange platform
Pick a platform
For those looking to buy stablecoins in Canada, choosing a top-rated and trusted exchange is an important first step. The two most popular choices in terms of safety and customer service are NDAX and Coinberry.
Register your account
You will need to sign up and complete the verification process.Join NDAX Join Coinberry
Fund your account and start trading
Once your account is set up, you will need to deposit funds before you can start trading. The best option is to use a Canadian exchange where you can deposit and withdraw Canadian dollars. This helps you to save on transaction and trading fees.
Using your credit card
A popular and simple way to buy stablecoins is online using your credit card. You will need a wallet address and, if it is your first purchase, proof of identity.Buy stablecoins with your credit card
It is not clear today which stablecoin models will prevail. Investing in cryptocurrencies comes with a risk; therefore, it is crucial that as a potential investor you conduct your own due diligence before trading cryptocurrencies.