What are stablecoins and how do they work?
A stablecoin is a kind of digital coin, whose value is attached to a fiat currency (like the dollar), or other assets like precious metals. This link was created to maintain price stability.
They represent the blend of the best crypto features with those of fiat currency.
We all know that popular cryptocurrencies like bitcoin, are highly volatile, even in a 24 hours time warp, making them not suitable for everyday use. Digital money should have low inflation for people to utilize them as they do with traditional currency, but this wasn’t happening. That’s why stablecoins were created.
Types of stablecoins
- Fiat-collateralized stablecoins
They keep a fiat currency reserve like the U.S. dollar or Euro as collateral to issue digital coins. Even though the collateral can also be precious metal, oil, and many more, most stablecoins use dollars. These supplies are maintained by independent keepers and are frequently audited for adherence to the necessary compliance.
- Crypto-Collateralized stablecoins
These types of stablecoins are backed by other cryptocurrencies, which can be highly volatile. To fix this issue, crypto-collateralized stablecoins are “over-collateralized”. This means a larger amount of cryptocurrency tokens is kept as a reserve for issuing a lower number of stablecoins.
- Non-collateralized stablecoins
They don’t use any kind of reserve. Instead, they involve a working mechanism to keep the price stable. For example, the dollar-pegged coin uses a consensus mechanism to increase or decrease the supply of tokens based on their needs. This can be attained by implementing smart contracts.
Since 2017, hundreds of teams around the world have declared stablecoin initiation, but less than 30% of those released continue to exist. Usually, this happens because they fail to maintain their 1:1 peg.
Even though stablecoins have had some issues in the past, they are a very important component of the cryptocurrency market. Through a lot of different mechanisms, stablecoins can remain almost steady at set prices, allowing them to be used reliably.
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