How Do Stablecoins Maintain Their Price Points (and Which One Is the Most Secure)?
Stablecoins were developed in response to the volatility experienced by digital assets. The idea is that, if cryptocurrency had a stable price that made it a better store of value, people would be more likely to adopt and use the technology. The complexity of the industry and the desire to innovate, however, have resulted in several variations of the same asset.
This leads many to inquire further into how stablecoins maintain their price points and, ultimately, which solution is the safest to use. If you have found yourself looking deeper into stablecoin products and need a comprehensive explanation of the different types that exist, continue reading below to learn more about these products.
What Stablecoin Models Are on the Market?
1. Centralized and Backed By Fiat
The first model utilized by stablecoin assets is the centralized, fiat-backed model. Using this system, the price of a stablecoin is tied to the price of a fiat currency, which is often much less volatile and more dependable than a digital asset. Each individual stablecoin then represents a unit of fiat currency, which is stored away in a bank account so that users can trade in their stablecoins and receive fiat in exchange (or vice versa). While these models are the most popular and do maintain their price well, there is still a lack of transparency and the possibility of volatile price swings due to low supply and high demand.
2. Decentralized and Backed By Crypto
Some developers have taken note of the inherent issues of a centralized model, turning to cryptocurrency assets for help. In this decentralized system, stablecoins are based on the value of crypto rather than fiat currencies, which helps to increase transparency in the system and make the experience of using stablecoins more secure. Of course, this model also comes with its disadvantages, which include the extreme volatility that digital assets experience and a more complex system needed to go about supporting the stablecoin.
3. Centralized and Backed By Commodities
Back when ICOs were taking over the market, there was no shortage of projects that offered cryptocurrencies backed by physical commodities. Whether those commodities were gold, real estate, or oil, many developers promised to offer individuals digital representations of physical goods. Of course, while being able to trade in your crypto for stable assets is desirable to many, this model still relies on centralization and can be quite complicated if a user does want to claim physical goods or other types of products in exchange for their stablecoins.
4. Decentralized and Algorithmic-Based
On the extreme end of the spectrum, we have stablecoin solutions that are not tied to any assets but rely on algorithms to maintain certain price points. These algorithms will typically burn and create coins to keep the asset stable and may or may not be protected by crypto or fiat in the event that the user base needs to sell a large volume coins back to the system. These models are often very complex and depending on the system utilized (these projects will pull different concepts from existing models and fuses them together), their disadvantages will vary.
When it comes to stablecoins or crypto in general, all assets come with their fair share of risk and it is important to consider the pros and cons of investing before you choose to buy a digital asset. If you are looking into storing some of your wealth in stablecoins, use the guide above as reference to help you better understand the current options on the market!