Stablecoins are a type of cryptocurrency that aim to maintain a stable value relative to another asset, such as a fiat currency, a commodity, or another cryptocurrency. Stablecoins are designed to overcome the high volatility of most cryptocurrencies, which makes them less suitable for everyday transactions and payments. Stablecoins can also offer some advantages over traditional payment systems, such as faster settlement, lower fees, and global accessibility.
There are three main types of stablecoins, based on the mechanism used to stabilize their value:
- Fiat-collateralized stablecoins are backed by a reserve of fiat currency, such as the U.S. dollar, held by a third-party entity. These stablecoins are redeemable from the issuer at a fixed rate and can be traded on exchanges. The most popular stablecoin of this type is Tether (USDT), which claims to be fully backed by U.S. dollars, although this has been disputed and fined by regulators¹.
- Crypto-collateralized stablecoins are backed by a reserve of another cryptocurrency, such as Ethereum, held in a smart contract. These stablecoins are overcollateralized to account for the volatility of the underlying asset and are subject to liquidation if the collateral falls below a certain threshold. The most popular stablecoin of this type is DAI, which is pegged to the U.S. dollar and backed by various crypto assets².
- Algorithmic stablecoins are not backed by any reserve, but instead rely on an algorithm that adjusts the supply of the stablecoin according to the market demand and price. These stablecoins are designed to mimic the function of a central bank, but without the need for any intermediary or collateral. The most popular stablecoin of this type is TerraUSD (UST), which is pegged to the U.S. dollar and uses a dual-token system to regulate its supply³.
Stablecoins are an important innovation in the cryptocurrency space, as they offer a more reliable and convenient way to use digital assets for various purposes, such as remittances, e-commerce, DeFi, and more. However, stablecoins also face some challenges and risks, such as regulatory uncertainty, security breaches, governance issues, and market competition. Therefore, users and investors should do their own research and due diligence before using or holding any stablecoin.
Some important keywords for this post are:
- Stablecoin
- Cryptocurrency
- Volatility
- Fiat-collateralized
- Crypto-collateralized
- Algorithmic
- Pegged
- Redeemable
- Collateral
- Liquidation
- Supply
- Demand
- Price
- Remittances
- E-commerce
- DeFi
