A stablecoin is a type of cryptocurrency that tries to maintain a stable value by being pegged to another asset, such as a fiat currency, a commodity, or a basket of assets.
A cryptocurrency is a digital or virtual currency that uses cryptography to secure its transactions and control its creation. Cryptocurrencies are usually decentralized and operate on a peer-to-peer network, without the need for intermediaries or central authorities.
The main difference between a stablecoin and a cryptocurrency is that a stablecoin aims to reduce the volatility and risk that are inherent in most cryptocurrencies, while a cryptocurrency aims to provide an alternative and independent form of money that is free from external influence and manipulation. Stablecoins are more suitable for everyday transactions, as they offer more predictability and stability in their prices. Cryptocurrencies are more suitable for long-term investments, as they offer more potential for growth and innovation in their technology and value.
There are different ways that stablecoins can achieve price stability, such as:
Fiat-Collateralized Stablecoins: These are stablecoins that are backed by a reserve of fiat currencies, such as the US dollar, the euro, or the yen. The stablecoin issuer holds the fiat currency in a bank account or a trust and issues the stablecoin at a fixed exchange rate. For example, one Tether (USDT) is always equal to one US dollar.
Commodity-Collateralized Stablecoins: These are stablecoins that are backed by a reserve of commodities, such as gold, silver, or oil. The stablecoin issuer holds the commodity in a vault or a warehouse and issues the stablecoin at a fixed exchange rate. For example, one Digix Gold Token (DGX) is always equal to one gram of gold.
Crypto-Collateralized Stablecoins: These are stablecoins that are backed by a reserve of other cryptocurrencies, such as Bitcoin, Ethereum, or Binance Coin. The stablecoin issuer holds the cryptocurrency in a smart contract and issues the stablecoin at a variable exchange rate. The stablecoin is overcollateralized to account for the volatility of the underlying cryptocurrency. For example, one DAI is always equal to one US dollar, but it is backed by at least 150% of Ethereum.
Algorithmic Stablecoins: These are stablecoins that are not backed by any reserve, but rather by an algorithm that adjusts the supply and demand of the stablecoin to maintain its price stability. The stablecoin issuer uses a smart contract to create or destroy the stablecoin according to market conditions. For example, one TerraUSD (UST) is always equal to one US dollar, but it is backed by the demand for Terra's blockchain services.
