What is a Stablecoin? A Comprehensive Guide for Beginners
What are Stablecoins?
Stablecoin is a type of cryptocurrency and is considered to be a digital asset-backed or pegged by gold or any fiat currency. Stablecoins are best known for their hybrid qualities i.e., stability like the fat currencies and the high security and speed of cryptocurrencies.
Stablecoins have gotten much admiration during the last decade in the crypto industry. They have gained the trust of people due to their stability and high security with hashing, encryption and cryptography. Stablecoin aids in real-time transactions and it can also be used to transfer the value in peer-to-peer transactions.
Why Do We Need Stablecoins?
Bitcoin (BTC) was first launched back in 2008 and gave people another perspective on trading and payments at a global level. By then started a journey in the crypto industry which is the evident of launch of thousands of cryptocurrencies. People use digital assets for trading and to carry out global transactions.
People couldn’t fully rely on cryptocurrencies due to the high rate of volatility of digital assets like Bitcoin. They feared that they might face loss in trading and transactions if the value fluctuates in a negative manner. There comes the concept of stablecoins 2014 which entrusted people a secure way of payment solutions.
Stablecoin was a step toward incorporating a digital asset having qualities of cryptocurrencies but backed or pegged by the gold of fiat currencies like USD and EUR. Till now, more than 200 stablecoins have been introduced in the market but Tether (USDT), USD Coins (USDC), TrueUSD (TUSD), and Dai (DAI) are the prominent stablecoins in the cryptoindustry.
Working Mechanism of Stablecoins
Stablecoins are known for their stability. A stablecoin’s value does not fluctuate like the other coins i.e., BTC, ETH and other crypto assets. Stablecoins are backed by gold or fiat currencies and hence can also be used for real-time transactions.
Stablecoins pegged to fiat currencies are properly regulated by a custodian who maintains and regulates the fiat currency reserve. Stablecoins can be either centralized or decentralized which can be centralized by maintaining the demand and supply.
The price of stablecoins can be maintained as the central banks issue and stabilize the fiat currencies. Stablecoins are stabilized pegging to any physical commodity i.e., fiat currencies, gold or by algorithms. Moreover, crypto backing, commodity backing and algorithm backing maintain the value of stablecoins.
Types of Stablecoins
More than 200 stablecoins have been introduced in the market which are widely used by the crypto community. If we categorize the stablecoins, there are three main categories of stables coins:
Fiat-Collateralized Stablecoins
Such stablecoins which are directly pegged to fiat currencies are called fiat-collateralized stablecoins and are equal to the fiat currency as 1:1. Each stablecoin is always backed by some specific fiat currency and US Dollar is the most common.
Such coins are used for real-time transactions across the world employing the US Dollar. USDT and USDC are the most common digital assets that come under stablecoins.
Commodity-Collateralized Stablecoins
Stablecoins which are backed by commodities like gold, estate or any other metal are called commodity-collateralized stablecoins. Among other commodities, gold is considered to be a more reliable commodity to back the stablecoins.
Tether Gold (xAUT) and Paxos Gold (PAXG) are considered to be the most prominent commodity-backed stablecoins.
Crypto-Collateralized Stablecoins
Such digital assets which employ one or more cryptocurrencies as collateral to gain stability are called crypto-collateralized stablecoins. These coins use a mixture of smart contracts instead of relying on the traditional financial systems are often considered as decentralized.
But these are backed by crypto assets and come under the category of stablecoins. DAI is the best and most famous stablecoin that comes under crypto-collateralized stablecoin.
Algorithmic Stablecoins
Such stablecoins do not use any kind of collateral to gain stability but gain price stability by marinating the force and circulating supply of the tokens. The issuance of these coins varies to maintain the rate according to the fiat currencies.
More coins are issued if the price goes above the target line and vice versa. Terra and ESD are examples of algorithmic stablecoins.
Conclusion
Stablecoins have revolutionized the trading and global payments solution in a secure way. They have the qualities of both financial systems i.e., traditional payment systems of central banks and the decentralized finance cryptocurrencies.
Stablecoins can be used for real-time transactions as they are backed by fiat currencies or commodities.
