Read on to learn the basics about stablecoins before you invest in any.
What are stablecoins?
Stablecoins are cryptocurrencies the value of which is pegged, or tied, to that of another currency, commodity or financial instrument.
Source: Investopedia
How do stablecoins work?
Stablecoins were designed to hold a constant value per coin of US$1. As its name suggests, it was as a way to provide price stability, by building it directly into the assets themselves.
Stablecoins act as a bridge between fiat currencies and cryptocurrencies. As price-stable assets, they are the answer to crypto volatility, and help to boost utility in everyday transactions.
What are the types of stablecoins?
Fiat-collaterized stablecoins
- Backed 1:1 by fiat currency, such as US Dollar, Euro or GBP
- For each stablecoin that exists, there is (theoretically) real fiat currency being held in a bank account to back it up
- The simplest form of stablecoins with limited fluctuation in its value
Eg. Tether (USDT), Gemini Dollar (GUSD)
Commodity-backed stablecoins
- Backed by physical assets like precious metals, oil, and real estate, with the most common being gold
- Helps to facilitate investments in assets that may otherwise be difficult due to geographical differences
- Have the potential to appreciate — or depreciate — in value over time
Eg. Tether Gold (XAUT) and Digix Gold (DGX)
Crypto-backed stablecoins
- Backed by another cryptocurrency
- Allows for more decentralization than their fiat-backed counterparts since everything is conducted on-chain
- Relatively complex type of stablecoin as they are often over-collateralized to absorb price fluctuations in the collateral
Eg. DAI
Algorithmic Stablecoins
- Also known as non-collateralized stablecoins as they are not backed by any assets or collateral
- Follow an algorithm for controlling the stablecoin supply (i.e. when market price falls below the price of the fiat currency it is pegged to, stablecoins in the market will be purchased to drive the price upwards; if price rises above the pegged currency, new stablecoins are created to adjust price downwards)
- Offer stability according to the tenets of market supply and demand
- As no collateral or assets are involved with algorithmic stablecoins for liquidity, it is possible that holders can lose their money in the event of a crash
Eg. TerraUSD (UST)
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