Jan 6
An Introduction to Stablecoins: What They Are and How They Work
Cryptocurrencies have been incredibly volatile since their inception. This makes them incredibly risky investment vehicles, as the value of your investment can swing wildly from one day to the next.
Stablecoins are a new type of cryptocurrency that seeks to address this problem by pegging their value to a stable asset, such as gold or the US dollar. This means that stablecoins are much less volatile than traditional cryptocurrencies, making them a much more stable means of payment.
What is a stablecoin in cryptocurrency?
A stablecoin is a type of cryptocurrency that is designed to minimise price volatility. Unlike other cryptocurrencies, which can fluctuate widely in value, stablecoins are pegged to a stable asset, such as gold or the US dollar. This makes them more suitable for use as a form of money, as they are less likely to lose their value over time.
The most popular stablecoin is Tether (USDT), which is pegged to the US dollar. Other examples of stablecoins include USD Coin (USDC), Paxos Standard (PAX), and TrueUSD (TUSD).
What are the types of stablecoins?
There are three main types of stablecoins: fiat-backed, crypto-backed, and algorithmic stablecoins.
Fiat-backed stablecoin
Fiat-backed stablecoins are different from cryptocurrencies like Bitcoin, which are not pegged to the value of any fiat currency.
A fiat-backed stablecoin is a type of digital currency that is backed by a traditional currency, such as the US dollar. This type of stablecoin is designed to maintain a 1:1 ratio with the traditional currency, meaning that 1 unit of these stablecoins will always equal 1 USD.
Fiat-backed stablecoins are popular because they offer the stability of a traditional currency with the flexibility of a digital currency. This means that they can be used in a variety of ways, including for payments, remittances, and more.
If you're interested in using a fiat-backed stablecoin, there are a few things you should know. First, you'll need to find a reputable exchange that offers this type of currency. Second, you'll need to hold onto your fiat currency to back the stablecoin.
Crypto-backed stablecoins
Crypto-backed stablecoins are a new and emerging type of stablecoin.
They are digital assets that are pegged to a stable asset, such as the US dollar. This type of stablecoin is backed by a reserve of cryptocurrency, which is used to stabilise the price.
They are different from fiat-backed stablecoins, which are pegged to the US dollar or other fiat currency.
Crypto-backed stablecoins have several advantages over fiat-backed stablecoins: They are resistant to inflation, since the price is pegged to a stable asset. They are also more transparent since the reserve is transparent and auditable.
Additionally, crypto-backed stablecoins can be used to make payments and transfers anywhere in the world, since they are not subject to the same regulations as fiat currencies.
Algorithmic stablecoins
Algorithms have been used to stabilise cryptocurrencies since the early days of Bitcoin. Algorithms are key to how cryptocurrencies work. With Bitcoin, for example, algorithms are used to verify transactions and prevent fraud.
These computer programs automatically buy and sell cryptocurrencies to maintain a target price. This helps to stabilise the price of the currency and protect investors from sudden price swings.
Different algorithms can be used to stabilise a cryptocurrency. The most common is known as the Seigniorage Shares algorithm and the Collateralized Debt Position algorithm.
Stablecoins have their pros and cons, and it’s important to understand them before investing in any stablecoin.
Advantages of stablecoins
Stablecoins can be used to hedge against the volatility of other cryptocurrencies. They can be used to store value, and they can be used to make purchases and payments. Stablecoins are a useful tool for both traders and investors in the cryptocurrency space. Stablecoins are also less volatile than other cryptocurrencies.
Disadvantages of stablecoins
Stablecoins also have their own disadvantages. Because they are pegged to a stable asset, they are much less likely to appreciate than traditional cryptocurrencies. This means that you could miss out on potential profits if the value of the underlying asset increases.
