What is Stablecoin? A stablecoin is a type of cryptocurrency where the value of the digital asset is supposed to be pegged to a reference asset. The reference asset is either flat money, exchange-traded commodities, or another cryptocurrency.
Stablecoins have a number of purported purposes. They can theoretically be used for payments and are in theory more likely to retain their value than cryptocurrencies, which are highly volatile. In practice, many stablecoins have failed to retain their “stable” value. Some types of stablecoins can be used for crypto staking, in which cryptocurrency owners can earn rewards by essentially lending out their holdings to help execute other transactions.
What is Stablecoin?
Stablecoins bridge the worlds of cryptocurrency and everyday fiat currency because their prices are pegged to a reserve asset like the U.S. dollar or gold. They are open, global, and accessible to anyone on the internet.
Stablecoins can also be defined as cryptocurrencies that claim to be backed by flat currencies, such as dollars, pounds, shekels, rubles, and more. Stablecoins try to tackle price fluctuations by tying the value of cryptocurrencies to other, more stable assets—usually fiat currencies. A fiat-backed stablecoin, for instance, maybe more stable because it is linked to a centralized financial system, which has an authority figure (like a central bank) that can step in and control prices when valuations are volatile.
Types of Stablecoins
There are four main types of stablecoins, which are listed and explained below.
Fiat-backed Stablecoins
The value of stablecoins of this type is based on the value of the backing currency, which is held by a third-party-regulated financial entity. In this setting, the trust in the custodian of the backing asset is crucial for the stability of the price of the stablecoin.
Fiat currency refers to government-backed currencies that are not backed by commodities like gold or silver. Instead, they are pegged to the value of real-world currencies, such as the U.S. dollar or the euro, and backed by reserves in those currencies.
Algorithmic Stablecoins
These are decentralized and focus on improving market price stability through pre-programmed supply to match asset demand. Algorithmic stablecoins come with the most risk because they are usually uncollateralized and rely on algorithms, financial engineering, and market incentives to peg the price of a particular asset.
Algorithmic stablecoins employ predefined stabilization measures encoded in the different smart contracts on Ethereum. Stablecoins are kept stable using collateralized assets, while algorithmic stablecoins are kept stable using smart contract algorithms.
Crypto-backed Stablecoins
Crypto-backed stablecoins are backed by other cryptocurrencies. Because the reserve cryptocurrency may also be volatile, such stablecoins are over-collateralized, which means that the value of cryptocurrency held in reserves exceeds the value of stablecoins issued. Crypto-collateralized stablecoins are backed by cryptocurrencies (usually ETH) rather than fiat currencies.
Commodity-backed Backed Stablecoins
A commodity-backed stablecoin is a cryptocurrency whose value is backed by some tangible asset, such as gold. For example, Paxos Gold is pegged to the price of one fine troy ounce of gold in the London Good Delivery market, which is currently $1,800. Tether Gold is another gold-backed stablecoin.
Commodity-backed stablecoins are collateralized using physical assets like precious metals, oil, and real estate.
FAQ
What is a stablecoin, and how does it work?
Stablecoins are cryptocurrencies that attempt to peg their market value to some external reference. They are more useful than more volatile cryptocurrencies as a medium of exchange. Stablecoins may be pegged to a currency like the U.S. dollar or to the price of a commodity such as gold.
Is Bitcoin a stablecoin?
A stablecoin is a token that has a non-volatile price, and Bitcoin is a cryptocurrency whose price is volatile in nature. Stablecoins are used to minimize the price volatility of cryptocurrencies like Bitcoins.
What is the point of stablecoin?
Stablecoins minimize typical cryptocurrency volatility by maintaining collateral in the form of reserves, often in U.S. dollars. Algorithmic stablecoins aim to provide steady value by adjusting supply based on pre-set rules.
Do stablecoins make you money?
You can earn money in a variety of ways by investing in stablecoins. Note that just holding stablecoins will not earn money since the value is pegged to stay at the same level. You can earn interest on your stablecoins by lending them out on various protocols.
What are the risks of stablecoin?
Reserves held by asset-backed stablecoins are subject to market, credit, and liquidity risks. There are heightened risks due to unregulated issuers and service providers, the opacity and complexity of the crypto ecosystem, and a lack of recourse for lost or stolen crypto assets.
Are stablecoins worth buying?
Stablecoins aren’t like traditional money minters. In this, they are unlike Bitcoin, Ethereum, and other crypto players. But they are more dependable and the least volatile. So they are a good option if you want a passive income and blockchain technology to speed up peer-to-peer payments and transactions.
