Cryptocurrency: What is a Stablecoin?
If you are new to the world of cryptocurrency, you might have been hearing the term stablecoin and wondering what it actually means. Well, stablecoin is not really a term, it is another form of currency in the crypto world. However, these currencies are a bit different from the regular cryptocurrencies you know, such as Bitcoin, Ethereum, Dogecoin, etc.
Unlike cryptocurrencies whose prices fluctuate and are extremely volatile, stablecoins are more stable in price while still offering the security and privacy people enjoy from cryptocurrencies. That makes stablecoins a preferred choice for investors looking for a way to keep their assets in the crypto space without the fear of them losing value in the future.
But what more should you know about stablecoins? How did they work and what are the biggest stablecoins presently in the crypto world. Read on to find answers to all these questions about stablecoins.
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What is a Stablecoin?
A stablecoin is a form of cryptocurrency but with a more stable value. While the prices of regular cryptocurrencies like Bitcoin and Ethereum fluctuates regularly, stable coins are more stable in price because their market value is pegged to another asset class, such as fiat currencies like the U.S dollar, commodities like gold and oil, precious metals like silver, and some other eternal commodities.
These types of digital currencies are useful when you quickly want to switch from volatile cryptocurrency to a more stable asset. For example, if you are holding BTC but perceived there is likely going to be a significant decrease in its price soon, you can quickly trade the BTC for a stablecoin to protect your holdings.
Additionally, stablecoins come in handy when you are looking to trade on some exchanges that don’t support fiat currencies. You can easily list an asset with a relatively stable value.
One unique thing about stablecoins is that they provide a midpoint between volatile but more secured cryptocurrency and fiat currency. That means with a stablecoin, you can enjoy all the amazing benefits cryptocurrency offers, including security and privacy and the stability that fiat currency provides.
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You can use stablecoins to send money anywhere across the globe, and at a relatively low cost, especially when compared to sending the money using traditional banks and financial institutions.
What Are the Different Types of Stablecoins
Yes, stablecoins are of different types and are categorized based on the kind of asset backing them up. While some are backed by fiat currency, there are also some backed by commodities and other cryptocurrencies. Let’s take a look at what each of these types of stablecoins is.
Fiat-backed stablecoins
These are stablecoins whose prices or values are pegged to fiat currencies, such as the U.S dollar, Euro, or Chinese Yen. These currencies serve as collateral for stablecoins. Other forms of fiat that can also back stablecoins are precious metals like silver or platinum. At the same time, it can be commodities like oil. However, most fiat-backed stablecoins are backed by the U.S dollar. The most example of this is USDT (Tether).
Commodity-backed stablecoins
Assets such as gold and real estate can also be a form of collateral for stablecoins. The most widely used for this purpose is gold. However, many people use diversified baskets for precious metals.
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Crypto-backed stablecoins
Stablecoins can be backed by cryptocurrency as well. In this case, the stablecoins are referred to as crypto-backed stablecoins. To remove the fear of volatility when crypto is backing stablecoins, the coin will maintain an overcollateralized position. That means the stablecoin will circulate at a much lower volume than the crypto backing it.
For instance, an ETH-backed stablecoin may issue only $500 worth of coins for every $2,000 of crypto in reserves instead of doing it at a ratio of 1:1.
Seigniorage style stablecoins
Instead of being backed by assets or currency, this type of stablecoin is backed by an algorithm or process. A good example of this is basecoin which uses a consensus mechanism that helps to maintain a healthy balance between its supply and demand. Most of these stablecoins use a smart contract designed to run and function on a decentralized platform. This makes them unanswerable to any government or financial institution.
