Stablecoins Explained: How They Work and How They Affect the Lives of Regular Individuals
The most commonly used type of cryptocurrencies.
Since the invention of stablecoins, cryptocurrencies have enjoyed considerable attention and alternative liquidity alongside more investment opportunities. In this section, we’ll explore what stablecoins are and how they affect the life of regular individuals.
What is stablecoin?
Stablecoins are cryptocurrencies that are pegged to a specific asset. In other words, stablecoins can only have the market value of their asset class. They’re divided into four categories: fiat-based, commodity-based, crypto-based, and non-collateralized stablecoins.
Why stablecoins occurred?
Stablecoins occurred because there was too much volatility in the crypto market. Therefore, investors had a hard time providing liquidity in terms of their respective national currencies. To solve this, various types of stablecoins have been launched into the market.
What are the properties of stablecoins?
Their value is pegged to a specific asset. Therefore, its value stays relatively safe when compared with the crypto markets. Secondly, stablecoins provide most of the liquidity to crypto markets and, as a result, they’ve flourished decentralized financial markets with their own activities.
How stablecoins work?
Because stablecoins are generally pegged to a certain asset, their supply, and demand change according to the market value of their underlying assets. If their price has reduced below their market asset, they decrease the supply so that their value is being equal to their underlying asset. But if their value goes above the underlying asset, they increase the supply until its value is equal to their underlying asset.
Fiat-backed stablecoins are cryptocurrencies that being supported with fiat currencies. Because they provide custodial services to maintain their price and they’re generally subjected to auditing. Tether (USDT), US Dollar Coin (USDC), and Paxos Standard (PAX) are some of the examples of fiat-backed stablecoins.
Commodity-backed stablecoins are cryptocurrencies that are supported by their underlying commodities. These include gold-backed stablecoins, oil-backed stablecoins, timber-backed stablecoins, etc. Their value is entirely dependent on the market value of their respective commodities. Like fiat-backed stablecoins, commodity-backed stablecoins are subjected to auditing and compliance checks. To give an example, Tether Gold (XAUT) and Paxos Gold (PAXG) can be shown as examples for commodity-backed stablecoins.
Crypto-backed stablecoins are cryptocurrencies that are being backed by various cryptocurrencies and these kinds of cryptocurrencies are over-collateralized to keep them stable. Despite they’re not simply cryptocurrencies, their value mimics their respective cryptocurrency. DAI (DAI), Wrapped Bitcoin (WBTC), Wrapped Ethereum (WETH), and Wrapped Binance Coin (WBNB) can be shown as examples.
Non-collateralized stablecoins don’t really have any assets to back down their respective stablecoin. Instead, their supply and demand have been determined by an algorithm. These algorithms work like central banks to make stablecoin prices stable. Kava’s USDX and Terra’s UST can be shown examples for non-collateralized stablecoins.
How stablecoins affect our lives?
Firstly, stablecoins are the primary source of liquidity for cryptocurrency exchanges and decentralized finance (DeFi) protocols. Therefore, most of the financial activities concerning cryptocurrencies are being conducted on stablecoins on various cryptocurrency transactions. Therefore, more liquidity is provided for exchanges and DeFi protocols and it allows alternative financial protocols to flourish. As cryptocurrencies and DeFi protocol use is increasing at a faster pace, the use of stablecoins and DeFi protocols will increase at a faster pace and they could help the financial ecosystem.