What is a stablecoin?

What is a stablecoin? this article, we will discuss what stablecoins are and how they differ from other cryptocurrencies. We will also explore the benefits of using stablecoins and look at some of the most popular stablecoins on the market today. Finally, we will take a closer look at how stablecoins help to stabilize the cryptocurrency market as a whole. Stay tuned for all the details!

Cryptocurrencies are becoming more and more popular with each passing day. The main reason for this sudden rise in popularity is because they can provide users with an alternative way to store value, which isn't controlled or regulated by any single entity like governments or banks do currently (and often). One type of cryptocurrency that has been gaining momentum recently is called “Stablecoin” - these coins were designed as alternatives due to their low volatility rates; meaning it doesn't fluctuate wildly throughout certain periods where there might be expected instability (such as Bitcoin's value during the 2017 bull-run and subsequent crash).

So, why are stablecoins useful?

A stablecoin is a type of cryptocurrency that is designed to minimize price volatility. Stablecoins are pegged to assets with stable values, such as fiat currencies or precious metals. This means that stablecoins can be used to store value in the same way that fiat currencies or precious metals can. However, stablecoins also have the added benefit of being much more efficient and cheaper to transact with than traditional fiat currencies or precious metals.

Types of stablecoins

1. Crypto-backed Stablecoins

Cryptocurrencies backing up stablecoins may seem a bit out of place at first. After all, cryptocurrencies are known for their volatility. So how can you expect stability in a currency that is backed by them? In fact, crypto-collateralized stablecoins offer better decentralization than fiat-collateralized stablecoins. And because they are over-collateralized, they can absorb price fluctuations more easily.

Decentralization is the most important quality to look for when choosing a stablecoin. A crypto-backed stablecoin can help make processes more trustless and secure, with improved transparency. Without any single entity in control of your funds, you have the benefit of decentralization.

The most common example of a crypto-backed stablecoin is DAI (issued by MakerDao), which is over-collateralized with crypto assets.

2. Algorithmic Stablecoins

The latest stablecoin category is non-collateralized or algorithmic. These types of stablecoins don't use assets or collateral for security. So, if they're not backed up by anything, how are algorithmic stablecoins still classified as being a stablecoin?

Algorithmic stablecoins, otherwise known as non-collateralized or seignorage shares, are a new type of cryptocurrency that maintains its value by following an algorithm. This offer many benefits over traditional fiat currencies, including price stability. With the rise in demand for stablecoins, new coins will be created to reduce the price back to its normal level. If there is low coin trading volume, existing investors will purchase more coins in order to reduce circulating supply and stabilize prices.

In essence, algorithmic stablecoins might provide stability according to market supply and demand. Furthermore, it's worth noting that algorithmic stablecoins have the greatest degree of decentralization and independence. On the other hand, as a result of continuous development, such algorithmic blockchain platforms are dependent on success for their viability. You should be aware that since there is no collateral behind algorithmic stablecoins for liquidity, everyone may lose their money in the case of a fall. A clear example of this is the Terra Luna crash that took place in 2022, making UST's (Terra's algorithmic stablecoin) value deppeg to the USD and LUNA's value go to $0.

However, after this kind of inconvenience, there are algorithmic stablecoins being developed with over-collateralization, to prevent things like these from happening again.

3. Fiat-collateralized Stablecoins

The most common type of stablecoin is the fiat-collateralized stablecoin. These coins are backed by a fiat currency, such as the Euro, GBP, or USD. Fiat-collateralized stablecoins are considered to be the simplest type of stablecoin, with a 1:1 ratio backing. This means that onestablecoin is equal to one unit of currency (e.g., one dollar or one euro).

In other words, for each fiat-backed stablecoin in existence, there is an equivalent amount of real currency kept in a bank account. If a user wants to redeem their coins, the organization managing the stablecoins will take out the corresponding amount of money from their reserve and send it to that person's bank account. The same number of stablecoins are then removed from circulation or destroyed.

One major advantage of fiat-backed stablecoins is that they are structurally simpler than other types of stablecoins. This simplicity offers beginners the valuable opportunity to gain a better understanding of cryptocurrencies. Therefore, fiat-backed stablecoins could play a significant role in promoting large-scale adoption of stablecoins. Another benefit of these types of coins is that they tend to be more value stabilized since they're backed by the country's economy, which usually experiences fewer fluctuations in value than other assets.

The most common fiat-collateralized stablecoin is USDT (tether), which is pegged to the US dollar. Being this currently the biggest stablecoin in terms of market capitalization, followed by BUSD (Binance's Stablecoin) and USDC (Coinbase's stablecoin).

4. Commodity-backed Stablecoins

Commodity-backed stablecoins are, as the name suggests, backed by different types of interchangeable assets such as precious metals. The most common commodity used to collateralize commodity-backed stablecoins is gold.

Additionally, you could discover a variety of other stablecoins with backing from things like real estate, oil, or precious metals other than gold. The owners of commodity-collateralized stablecoins effectively have ownership over a real asset with actual value. This is a significant advantage when compared to most cryptocurrencies.

Commodities are often associated with long-term price appreciation. As a result, such stablecoins tend to provide greater incentives for people who keep and utilize commodity-backed stablecoins. In addition, commodity-collateralized stablecoins also allow anyone around the globe to invest in precious metals like gold.

Stablecoins have typically only been available to those with a lot of money. However, commodity-backed stablecoins create new opportunities for investment for anyone, regardless of where they live.

Examples of commodity-backed stablecoins include Tether Gold (XAUT) and PAX Gold (PAXG).