Stablecoin 101: What It Is and How It Can Protect Your Money

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Whether or not you have invested in the crypto world, odds are, you are still familiar with the words blockchain and cryptocurrency. For more than a decade now, cryptocurrencies and blockchain have been fighting to come out on top. Nevertheless, their prices soaring up one day and plummeting the next can make anyone apprehensive.

While it is advised to keep your eyes peeled, if you are looking for an alternative that can act as your shield against potential losses, stablecoin is your answer.

Here’s the man of the hour, the stablecoin, decoded.

Introduction

True to its name, a stablecoin is a type of cryptocurrency with a constant price that remains stable under any circumstance.

Stablecoins endeavor to mimic or peg their market value to another asset or external reference. Their rate is pegged to that of entities like gold, gas, etc., or the value of government-issued money like dollars, euro, yen, and many more.

Working Mechanism

Stablecoins operate their strategies and operations through blockchain technology. They are utilized as a unit of account, medium of exchange, and value store under the section of payment tokens.

The most prominent stablecoins encompass Tether (USDT), Dai (DAI), and USD Coin (USDC), among many.

Some fiat currencies are very vulnerable to inflation, while others like Bitcoin (BTC) and Ethereum (ETH) are known to be highly unstable assets. Stablecoins — the torchbearers are specifically designed to maintain their value or achieve price stability, thereby stabilizing the variable crypto markets.

Stablecoins- types

Let’s have a look at the four categories of stablecoins.

Fiat-collateralized stablecoin

As the name suggests, an existing government-issued currency backs them like USD or pound. For every digital coin you get issued, you are required to offer an equivalent amount of fiat money as collateral.

Source: masterthecrypto.com

In other words, fiat-collateralized stablecoins have the same value as regular currency and are topping the charts as the most popular and widely used type of cryptocurrency.

To help you understand better, consider this.

Let’s say your currency is the USD; then each stable coin crypto for the dollar will have the same value, $1. Both of these currency ratios will always stay constant, as 1:1. To be specific, in Tether (USDT), 1 USDT is always valued at 1 USD.

However, we can not completely rule out frauds here since centralized groups and entities issue these coins with their own rules and protocols. Therefore, invest in an issuer you trust in.

Commodity-collateralized stablecoins

Though highly similar to fiat-backed coins, the commodity collateralized stablecoins differ from them in one aspect. Instead of fiat money, they use other kinds of interchangeable assets and goods as collateral, including gold, silver, diamonds, etc., precious metals, and minerals. Not only this, but they also utilize valuable commodities like oil and natural gas, exclusive real estate, etc.

If you are hunting an example of this one, check out Petro-Venezuela’s oil-backed cryptocurrency.

Cryptocurrency-collateralized stablecoins

In this case, the stablecoin is backed by cryptocurrencies. Using cryptocurrencies as collateral, the entire process thereby runs and operates on the blockchain in a decentralized manner. Crypto-collateralized stablecoins are mostly pegged with a 1:2 ratio.

source: pinterest.com

As cryptocurrency is an underlying asset, it is not conventionally secure and may have high volatility. To ensure that the supply of stablecoins remains unfazed by extreme price fluctuations, owing to cryptocurrencies’ highly volatile nature, many cryptocurrencies have to be held in collateral for every stablecoin.

Additionally, the high amount held as reserves gives people enough reasons to term it as “over-collateralized.” Example: Dai (DAI), backed by collateral on the Maker platform.

The complexity of cryptocurrencies puts this type behind its fiat-backed counterparts in the race.

Algorithmic stablecoins

Also called non-collateralized, either fiat money or cryptocurrency doesn’t back these stablecoins as the name gives away. That means algorithmic stablecoins do not involve the use of any reserve asset.

Instead, their stability relies on an algorithm. Smart contracts are in charge of administering the supply and demand, in turn assuring the stablecoin’s price stability.

The algorithmic system automatically generates new coins if the stablecoin is trading sky high. As another option, the system will buy coins in the market to cut down its circulating supply.

Source: okex.com

An example of this is Primecoin (XPM). Another example is the cryptocurrency base coin, which uses a consensus mechanism to determine whether it should increase or decrease tokens’ supply on a need basis.

This stablecoin type might come across as the most complicated one among the four, but the algorithmic systems are similar to central banks’ managing supply processes.

Importance of stablecoins

Like their thousand counterparts in the sea of cryptocurrencies, stablecoins too strive to provide advanced functions of traditional money across the world.

Here’s a glance at some of their most significant benefits.

Price stability

Stablecoins are designed to have a stable value over any time. This makes many crypto geeks and investors (including us!) consider them a sanctuary for investors.

Evidently enough, the value of fiat money and significant cryptocurrencies are experiencing dramatic rising and plunging day by day, which makes stablecoins an imminent option.

If you, too, are wary of investing, the good news is now; you can now store your wealth in an asset without seeing any risk of loss due to inflation.

Privacy and decentralization

Since stablecoins are a type of cryptocurrency, they operate on the same powerful technology and systems as thousands of other cryptos.

The catch lies in the fact that, while cryptocurrencies are decentralized, there might still be an underlying need for ties with a fiat currency’s banking system.

Hence, this can be a good headstart for you if you aren’t ready to intotally vest in the crypto land.

Programmable currency

Stablecoins are programmable and can be customized according to the users’ needs.

This is mainly brought into action by rewards or loyalty programs.

As an example, if a company mounts its business on top of its stablecoin, it can devise an application where users can easily and quickly check their stablecoin and rewards at once.

A means to buy cryptocurrencies

You aren’t obliged to use Tether to purchase cryptocurrencies in India. However, using stablecoins in cryptocurrency exchanges in India reduces your transactional fees.

Moreover, Tether is the most employed method to acquire cryptocurrencies.

Conclusion

Stablecoins are known to promote faster and cheaper payment transactions.

Employing stablecoins, you can transfer and accept payments in and from any corner of the world with just a couple of taps on your phone. You can also trace your funds and payment activities in real-time!

With cryptocurrencies taking over the industries today, digital assets like stablecoins have the flame to usher us into the digital world.

Safeguarding our money against the severe consequences of market inconsistencies and aiding faster, adaptable, and secure digital payments, stablecoins are here to help us attain fiscal steadiness and win the war against volatility that deters us.


Stablecoin 101: What It Is and How It Can Protect Your Money was originally published in Coinmonks on Medium, where people are continuing the conversation by highlighting and responding to this story.