What is stablecoin?
Stablecoin is a type of cryptocurrency which is backed by or pegged to gold or fiat currencies. Stablecoin is a unique kind of digital currency that has hybrid qualities i.e., the high speed and security of cryptocurrencies and the stability of fiat currencies.
Due to their high speed, security, reliability and stability, stablecoins have got much admiration from the crypto community. During the last decade, people’s trend shifted toward stablecoins for trading and payment solutions across the world. Stablecoins are admired due to their encryption, hashing, and cryptography. Stablecoins are helpful in peer-to-peer transactions and real-time transactions for transferring value.
Bitcoin (BTC) was launched back in 2018 and initiated the journey of cryptocurrencies. It gave a new payment and trading perspective across the world. Since then thousands of digital assets have been introduced in the market. People use different cryptocurrencies for payment solutions, trading and value transfer at a global level.
People couldn’t much rely on digital assets like Bitcoin (BTC) due to its decentralization and high rate of volatility. They needed digital assets with low volatility rates for payment solutions. There comes the concept of stablecoins which has the lower volatility rates upon which they can rely which are pegged to the fiat currencies.
Stablecoins were launched back in 2014 and got the attention of the crypto community for secure and reliable payment solutions. Stablecoins carved a way for people to get close to cryptocurrencies by assuring the qualities of fiat currencies. Till now, more than 200 stablecoins have been introduced in the crypto market of which Dai (DAI), TrueUSD (TUSD), USD Coin (USDC) and Tether (USDT) are the giants of stablecoins.
How do Stablecoins Work?
People rely on the stablecoin for its stability and its low volatility. The value of the stablecoins does not fluctuate like the other digital assets as it is pegged to gold or fiat currencies. As it is backed by fiat currencies, it can be used for real-time transactions.
Stablecoins are pegged by fiat currencies and hence are regulated by the respective custodians who regulate and maintain the fiat currencies. Hence, stablecoins are centralized and few are decentralized which can be centralized by maintaining the supply and demand.
Types of Stablecoins.
Currently, more than 200 stablecoins are circulating in the crypto market. Depending upon their features we categorize all the stablecoins into four main categories.
- Fiat-collateralized Stablecoins
- Commodity-Backed Stablecoins
- Crypto-collateralized Stablecoins
- Algorithmic Stablecoins
1. Fiat-Collateralized Stablecoins
Such stablecoins which are backed by traditional fiat currencies held in the reserve are known as the fiat-collateralized stablecoins. The ratio of such stablecoins is one-to-one (1:1) to the fiat currency they are pegged to. USDC (USD Coin) and USDT (Tether) are the most common examples of fiat-collateralized stablecoins.
2. Commodity-Backed Stablecoins
These are somehow related to the fiat-collateralized stablecoins but they are backed by gold, silver or any other precious metal or sometimes by the estate. However, gold is considered to be a reliable standard for commodity-backed stablecoins. Paxos Gold (PAXG) and Tether Gold (xAUT) are significant examples of stablecoins.
3. Crypto-Collateralized Stablecoins
These stablecoins are backed by multiple cryptocurrencies to gain stability. A mixture of different digital currencies and smart contracts are utilized instead of relying on traditional financial systems. Sometimes they are regarded as decentralized but these are the stablecoins backed by the crypto assets. DAI is the best and most well-known example of crypto-collateralized stablecoins.
4. Algorithmic Stablecoins.
These stablecoins do not require any collateral for stability rather its stability depends upon the issuance of the stablecoins. Stability in such coins is gained by maintaining and regulating the balanced issuance of stablecoins i.e., more stablecoins are issued if the price goes above the target price and vice versa. ESD and Terra are the best examples of algorithmic stablecoins.
Stablecoins have become an integral part of global payment solutions due to their stability. Although, these are backed by the traditional financial system but have marked their name in cryptocurrencies. As the crypto space continues to evolve, stablecoins will likely play an even more significant role in shaping the future of digital finance.
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