The emergence of Cryptocurrency led the beginning of a transparent, secure, instantaneous, and decentralized payment system. This era was intended to distribute power and create a trusted system across all industries. Despite all these, Cryptocurrencies are still not being happily adopted worldwide because of the inherent volatility observed in its pricing. There are around 2000+ cryptocurrencies each one having a tendency to either increase or decrease 10–20% in value. This unpredictable volatility makes it hard to use cryptocurrencies for daily transactions. So to tackle this issue, stablecoins were formed.
A stablecoin is a type of cryptocurrency that isn’t volatile and is backed or pegged by assets like the fiat currency, the United States dollar, or precious metals (gold). Stablecoins operates similarly as the other cryptocurrencies operate. The only difference they carry is enhanced stability. They offer a faster settlement, fewer regulatory hurdles. Trading cryptocurrency has a risk of loss due to price fluctuation this can be also reduced using stablecoins.
Types of Stablecoins
A stablecoin is always pegged by an asset of stable value so that even if the general cryptocurrency market capitalization increases or decreases in a single day stablecoins has a fixed valuation in relation to its underlying asset. Stablecoins are usually pegged in the ratio of 1:1 so that the total number of stablecoins in circulation is backed by assets held in reserve. Depending on how the backing or pegging of coins is done they are four different types of stablecoins:
- Fiat-pegged stablecoin: The coins that are fully backed by fiat money are termed as Fiat-backed stablecoin. The ratio of 1:1 is pegged meaning that $1 of stablecoins is equivalent to $1 of fiat money. This type is almost centralized as there will be a company or a central entity in between for managing the acceptance of new fiat and issuing of fiat-backed tokens of the corresponding amount.
- Commodity-pegged Stablecoin: Commodity-backed stablecoin are the coins that are fully backed by commodities that are able to be interchangeable. The most common commodity used is gold in the ratio of 1:1 meaning one coin is equivalent to a specific value of gold. This type of pegging is almost centralized as there will be third-parties involved in managing the system
- Cryptocurrency-pegged stablecoin: The coins that are backed by top-ranked cryptocurrencies with large market capitalization such as Bitcoin (BTC) or Ether (ETH) are called as cryptocurrency-pegged stablecoins. In order to lower the volatility risk, a coin is backed by a combined group of cryptocurrencies rather than a single cryptocurrency. This stablecoin is decentralized in nature because a user is required to stake a certain amount of cryptocurrencies into a smart contract which will then result in the creation of a fixed ratio of stablecoins.
- Algorithm-pegged stablecoin: These coins don’t need companies to hold any asset on hand instead a set of rules (smart contracts) is employed in the code that aims to match the supply of the token with the demand. In other words, the coin is pegged by manipulating the coin supply on the market.
Stablecoins in use Today
Tether (USDT): It is a stable coin issued by a company called Tether Limited and pegged by US dollar (USD). Tether has a huge daily volume because of its stability since its introduction in 2015.
GUSD (Gemini USD): It is a stablecoin pegged in the 1:1 ratio with the US dollars and issued by a crypto exchange known as Gemini.
USDC (USD Coin) — It is a fiat pegged stablecoin issued by Circle and Coinbase.
DAI — It is crypto- pegged stablecoin created by MakerDAO and does not reply on the centralized entity or third party and depends completely on blockchain. The price stability is achieved through an autonomous system of smart contracts — called Collateralized Debt Position (CDP) — that responds to varying market dynamics.
TrueUSD (TUSD): It is a stablecoin that is pegged by the fiat currency (USD). It was created as an alternative to Tether for more transparency. TUSD was first introduced on Bittrex and is held in the bank accounts of multiple trust companies that have signed escrow agreements that utilize smart contracts rather than in a bank account controlled by a single company. These bank accounts are published every day and are subject to monthly audits.
Stablecoins is a new venture that has the potential to be an alternative to the traditional cryptos and help to raise the growth of the cryptoworld which is hampered due to the volatility in the Cryptocurrency prices.
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