Stablecoins have emerged as a new type of cryptocurrency in recent years, aiming to provide stability in the volatile world of cryptocurrency. While cryptocurrencies, such as Bitcoin and Ethereum are notorious for their price volatility, stablecoins are intended to maintain a stable value in relation to a traditional currency or asset.

Because of this stability, stablecoins have become an appealing option for those looking to gain access to financial services and participate in the global economy, particularly those who are unbanked or underbanked. This article will look at the applications and challenges of stablecoins in promoting financial inclusion.

What Are Stablecoins?

Stablecoins are cryptocurrencies that are intended to keep their value stable in relation to a traditional currency or asset, such as the US dollar, gold, or another stable asset. Stablecoins achieve this through a variety of mechanisms, including pegs to a stable asset, algorithmic stabilization mechanisms, and collateralization.

Stablecoins are classified into three types: fiat-collateralized, crypto-collateralized, and non-collateralized. Fiat-collateralized stablecoins are backed by a traditional currency reserve, such as the US dollar or the Euro. Stablecoins that are crypto-collateralized are backed by a reserve of cryptocurrencies, such as Bitcoin or Ethereum. Non-collateralized stablecoins, also known as algorithmic stablecoins, use algorithms to maintain their value by dynamically adjusting supply and demand.

Stablecoin Applications in Financial Inclusion

Stablecoins can be used to promote financial inclusion in a variety of ways, particularly in developing countries and regions with limited access to traditional financial services. Some of the ways stablecoins are being used to promote financial inclusion are as follows:

Stablecoins can be used to facilitate cross-border remittances, allowing people to send and receive money with lower fees and faster settlement times. This is especially useful for those who are unbanked or have limited access to traditional remittance services.

Stablecoins can be used to facilitate microtransactions, allowing people to make small payments for goods and services without requiring traditional banking infrastructure. This is especially advantageous for small business owners and entrepreneurs who operate in cash-based economies.

For those who do not have access to traditional savings accounts, stablecoins can be used as a store of value and a means of saving. Over time, this can help people achieve financial stability and security.

Stablecoins can also be used to provide unbanked or underbanked individuals with access to financial services. Loans, insurance, and investment products are examples of services that are typically only available to those with a bank account or a credit history.

Stablecoin Challenges in Financial Inclusion

While stablecoins have the potential to promote financial inclusion, they also face a number of challenges that must be overcome in order for them to reach their full potential. Some of the difficulties that stablecoins face in promoting financial inclusion are as follows:

• Stablecoins operate in a regulatory gray area: Their legal status is unknown in many jurisdictions. This can cause confusion for users and businesses, slowing the adoption of stablecoins.
• Stablecoins require complex technical infrastructure to function: This includes blockchain technology, smart contracts, and stablecoin stabilization mechanisms. This may create technical barriers to entry for users and businesses who lack the necessary technical knowledge to use stablecoins.
• Adoption challenges: Adoption of stablecoins is difficult, particularly in areas with limited internet access or low levels of digital literacy. This may restrict the potential user base for stablecoins and impede their adoption.
• Risks of centralization: Some stablecoins are centralized, which means they are controlled by a single entity. This can lead to centralization risks, such as censorship, and undermine stablecoins' decentralization and democratization potential.

Stablecoins, like all cryptocurrencies, are vulnerable to security risks, such as hacking and theft. Stablecoin security is critical for their adoption and use in financial inclusion.

What Are the Risks and Hurdles Fiat-Backed Stablecoins Need to Overcome?

Counterparty Risk

The biggest risk of fiat-backed stablecoins is that they are not truly decentralized.

In order to be fully decentralized, there must be no central authority or intermediary involved in the operation of a cryptocurrency.

Fiat-backed stablecoins require some form of trust in a third party to hold your money and make sure it's safe from theft or loss.

This means you have less control over your funds than you would with other cryptocurrencies, such as Bitcoin or Ethereum.

Exchange Rate Risk

Another issue with fiat-backed stablecoins is that they typically use an algorithmically controlled supply rather than relying on market forces like supply/demand dynamics where prices rise when demand increases and vice versa; this means that prices increase suddenly without warning since there wouldn't be enough supply available.

Risks and Challenges of Crypto-Backed Stablecoins

There are three main risks associated with crypto-backed stablecoins:

Volatility Risk

The value of a stablecoin can fluctuate over time, which makes it less useful as a medium of exchange and store of value. For example, if you own $1 worth of USD Coin (USDC), but then the price drops by 50%, you'll only be able to buy half as much with USDC than before This could make people hesitant to accept it as a payment or invest in it at all.

Counterparty Risk

If there's ever an issue with the issuer's ability or willingness to honor their promise to redeem your coins for fiat currency, then this could lead investors into losing money because they don't have any legal recourse against them (as opposed to when dealing with banks).

Liquidity Risk

Even if everything else goes smoothly on exchanges where you trade these coins for dollars or other cryptocurrencies, there might not always be enough buyers at any given moment, so prices could spike quickly because demand exceeds supply rather than because something has happened within either market itself.

Risks and Challenges of Algorithmic Stablecoins

Algorithmic stablecoins are a relatively new concept in the crypto market, and they have some unique risks.

Vulnerability to Hacks

Because algorithmic stablecoins are often built on top of other blockchains, they're more vulnerable than traditional fiat-backed coins. This can happen if hackers find a way into the underlying blockchain or if there's an issue with the consensus mechanism (the algorithm used to determine who gets paid what).

Lack of Trust

Unlike traditional fiat currencies, which are backed by governments or central banks that have been around for decades or even centuries, algorithmic stablecoins rely on complex computer systems that may be difficult for many people to understand fully.

As such, this lack of understanding can cause them not only not to place their trust in these coins but also to feel hesitant about investing in them at all.

Lack of Transparency

Unlike traditional fiat currencies where all transactions are recorded publicly, anyone can see how much money is being printed each year and how much is being spent on things like interest payments or military budgets.

Conclusion

Stablecoins have the potential to promote financial inclusion by providing unbanked or underbanked individuals with access to financial services. They can facilitate cross-border remittances, microtransactions, savings, and access to financial services.

However, stablecoins face several challenges, including regulatory, technical, adoption, centralization, and security risks. To realize stablecoins' full potential in promoting financial inclusion, these issues must be addressed through regulatory clarity, technical innovation, education, decentralization, and security measures.

Stablecoins have the potential to transform the way people access and use financial services, particularly in developing countries and regions where traditional financial services are limited. They can help promote financial inclusion, reduce poverty, and foster economic growth by providing stability and security. As stablecoin use cases and challenges evolve, it will be fascinating to see how they will impact the global economy and promote financial inclusion.