Stablecoins: Definition, How They Work, and Types

Stablecoins: Definition, How They Work, and Types

Stablecoins: Definition, How They Work, and Types 150 150 DMC

For many, this is the drawback of the centralized model—the fact investors holding such stablecoins are taking on counterparty risk. Trying to navigate this jigsaw puzzle of regulation makes it incredibly challenging to innovate with legal certainty. The stablecoins in circulation today are not subject to clear regulation. The Terra collapse shows the need for regulation that defines stablecoins and what can qualify as a reference asset, and also puts in place clear consumer protections. Most major financial regulators are actively considering regulation for stablecoins, as well as the broader crypto asset ecosystem.

With transfer fees of less than $1, people have sent as much as a million dollars worth of USDC. Stablecoins’ value can be easily transferred around the world, even to areas where the US dollar is scarce, or the local currency is volatile. The dollar-pegged base coin, for example, employs a consensus method to increase or reduce token production based on demand. It’s a tokenized version of the asset that can be introduced into a blockchain ecosystem to help with seamless pass transactions, enhanced arbitrage, and value exchange.

What are stablecoins used for?

Stable coins enable us to bridge this gap between the stability of fiat currency versus cryptocurrency. The biggest example in this category is the DAI algorithmic stablecoin, which is pegged to the U.S. dollar but is backed by Ethereum and other cryptocurrencies. Collateralized stablecoins maintain a pool of collateral to support the coin’s value. Whenever the holder of a stablecoin wishes to cash out their tokens, an equal amount of the collateralizing assets is taken from the reserves.

If you’re looking to add some riskier assets to your portfolio, individual stocks can also fill that role. Tether is the world’s first stablecoin, the largest in terms of market capitalization, and the most transacted stablecoin in the market. Pegged to the U.S. dollar on a one-to-one basis, Tether claims its coin is backed 100% by a diverse mix of assets, most of which can be viewed on its website. The collapse shook the cryptocurrency world, with the world’s largest digital currencies feeling TerraUSD’s knock on effect. Terraform Labs’ founder Do Kwon intends to revive the fallen stablecoin, although the fruition of a potential comeback is yet to be seen.

what is a stablecoin

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USD Coins

Examples of crypto-collateralized stablecoins are Dai , Alchemix USD , and Magic Internet Money . Fiat-backed stablecoins are backed (or “collateralized”) by fiat currencies. There are many more use cases for stablecoins, especially for lending and borrowing in decentralized finance but unfortunately, are beyond the scope of this lesson but will be explored in future lessons. Traders use stablecoins to safely store value when the crypto market is really volatile and protect themselves against the price swings. To maintain this “peg”, stablecoins can be backed by external assets or use algorithms that dynamically adjust their supply relative to their demand at a given time. Gold-backed tokens can only be minted once the gold gets submitted to the custodian.

  • For example, Curve, one of the largest DeFi protocols having more than $20 billion total locked value, serves primarily as a marketplace for traders to trade different stablecoins with low fees.
  • The value is the property of the owner and is stored in a wallet, while the owner interacts with the payment system directly and has total independent control over the value.
  • One additional strategy to raise resources is to sell rights to future revenues against circulating stablecoins.
  • We believe everyone should be able to make financial decisions with confidence.
  • There is another type of stablecoin that is not collateralized but rather uses algorithms to balance supply and demand to maintain a stable price.

The idea is that traders can either create or destroy UST if its value rises or falls and this is what enables the value of UST to maintain its peg to $1. This means that algostables are the riskiest out of the three types and it remains to be seen whether algostables actually work in the long term. Find the approximate amount of currency units to buy or sell so you can control your maximum risk per position. It’s important to note here that our team understands what is required to build a fully-compliant and tradable stablecoin.

As soon as the timestamped records of custody events are recorded on the blockchain, smart contracts get triggered to mint tokens. The minted tokens are added to your organization’s holdings and can be issued to users. Protecting from high supplyUsers who want to redeem or sell their stablecoins should be able to do so at current face value minus transaction fees. It removes any incentive for sellers to market their stablecoins at discounted rates on secondary markets. Tether , the most traded cryptocurrency asset in the world on any given day, often surpasses the combined trading volumes for Bitcoin and Ethereum, which are the largest cryptocurrencies by market capitalization. This is not very different from central banks, which don’t depend on a reserve asset for keeping the currency’s value stable.

Along with Binance and other cryptos, PAX is also approved by NYDFS. Stablecoins might be best thought of as tools to use in an emerging DeFi system instead of other types of assets. These coins let traders and users of DeFi apps interact with a form of fiat currency directly on the blockchain. When acquiring a crypto-backed stablecoin, you provide some cryptocurrency as collateral to obtain stablecoins of equal value. Many cryptocurrencies don’t trade against the U.S. dollar or other fiat currencies, but they do trade against stablecoins like Tether .

what is a stablecoin

Now that we’ve understood the different types of stablecoins and how they work, it’s time to look at the most popular stablecoins available on the market. A stablecoin is a type of cryptocurrency whose value ties to another “stable” asset like the U.S. dollar, euro, or gold. Investopedia assets that “a currency should act as a medium of monetary value”; its value should remain relatively stable over time. However, in reality this system doesn’t always run as smoothly expected. There is a widespread misconception that stablecoins offer a similar level of stability to cash. Whereas cash is a liquid asset and will always represent the exact value of the currency it’s backed by, stablecoins can and do fluctuate.

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