The easiest way to understand what is and isn’t a stablecoin is to imagine being a cattle herder in Argentina, circa 2005.
Kidding, that’s not the easiest way to understand stablecoins but nonetheless we shall attempt to explain it using deliciously cladded steak analogies.
Cattle herding can be difficult, but it’s highly rewarding and profitable because Argentinian steak is demanded everywhere in the world. Here’s the problem though, from the dawn of the 2000’s the Argentinian Peso has depreciated from around 3:1 to 40:1 against the USD. This means that back in 2003, you could easily afford the new iPod but by 2008, it would be borderline impossible for you to buy the new iPhone. This is obviously a terrible feeling, because the new iPhone is cool and you want it!
But if we, as a collective village community had a stablecoin back then pegged to the USD, you wouldn’t have had this problem. The pegged Peso (pUSD) would retain its value against USD despite the real Peso dropping like flies that hover around your cattle. A stablecoin essentially IS an insurance against high volatility caused by things out of your control — a big problem in the cryptocurrency market since it’s mainstream adoption in 2017. Not only does this solve your problem with iPhones, but it also opens a realm of other possibilities between you and your fellow Argentinian neighbors. You could lend pUSD to Juan, the local baker because Juan can use your beef in baking delicious pies! Since the pUSD is pegged to USD, Juan is more comfortable taking a loan from you versus the local bank who only provides normal Pesos. In summary, a stablecoin also ACTS as mental insurance giving its holders added peace of mind to not only buy and sell real products, but also engage in more complicated financial transactions like borrowing and lending.
At this point, it is important to note that our example is a very simplified version of reality. For the above examples to work, our community of Argentinian herders and bakers need to agree internally that pUSD is pegged to USD at a 3:1 ratio (Pesos:USD), for example, regardless of the inflation or deflation for the Argentinian Peso. This gives us a barrier of protection against what our government does or does not do, ensuring the stability of our coin and therefore its value.
Another way to look at stablecoins is to think about gold, or more accurately – 12 golden bars stored in our cattle farm. This gold is worth a lot of money, but liquidating it can be difficult for a rancher who lives alone in the mountains. We’d have to move the heavy gold to Buenos Aires, then melt it down, then have Miguel make it to 100 bracelets, before finding women who like gold bracelets and selling it to them. Sure, this can be highly profitable but it is difficult to accomplish. So instead, what we can do is create a stablecoin using our 12 gold bars as collateral. By pegging it against our gold, we can now use digital tokens, pGold in our case, and spend those coins instead! Whatever we wanted to buy with profits from the 100 bracelets before, we can now buy with our digital stablecoin, pGold instead! This saves us a ton of time, and energy as our new medium of exchange allows us to buy and sell products digitally using the 12 golden bars we stored as collateral!
If steaks and golden bars aren’t your cup of tea, we can summarize stablecoins instead with the first sentence from its Wikipedia page: “Stablecoins are cryptocurrencies designed to minimize the volatility of the price of the stablecoin, relative to some "stable" asset or basket of assets. A stablecoin can be pegged to a cryptocurrency, fiat money, or to exchange-traded commodities (such as precious metals or industrial metals).”
Now go have a steak!
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