Your guide to stablecoins
Stablecoins provide the freedom and accountability of cryptocurrencies without the volatility. So how do they work and what are their benefits?
IntroductionAwareness and adoption of cryptocurrencies is steadily growing. One in 10 people in the UK have held crypto, while two in five respondents to a 2021 Gemini survey said they were “crypto-curious.” Trading and fintech apps alike are taking note, competing with crypto exchanges to reach an expanding market.But cryptocurrencies’ price volatility remains a concern for businesses and people that hold them. It’s hard to cost things in crypto when their value can grow and fall dramatically. And that undermines their utility as a store of value or medium of exchange. Stablecoins are one answer. They provide the freedom and accountability of cryptocurrencies without the volatility. But what is a stablecoin? How do they work? And how do customers buy them?Read on to learn about the basics of stablecoin and see why it’s a useful asset for both consumers and businesses.
What is a stablecoin?Stablecoins are cryptocurrencies whose prices are pegged to a fiat currency (eg USD Coin to the US dollar, Eurocoin for the euro, etc), a commodity (e.g Pax Gold to gold), or another cryptocurrency (eg DAI to Ether). The largest stablecoin is Tether (USDT) — it’s backed by collateral to the US dollar and has more than 72 billion coins in circulation as of August 2022. Stablecoins offer several advantages compared to other cryptocurrencies. They’re generally less volatile, and therefore provide more consistent and stable value. And since they’re often pegged to other assets, they’re easier to convert into fiat currency, providing a smooth onramp to crypto trading and ensuring liquidity.Compared to fiat currencies, stablecoins also offer better settlement times and foreign exchange rates in a trading environment. Traditional banking rails, with their slow settlement times, restrict when fiat payments and transfers can be executed. This imposes a barrier when commodities are in short supply and time is of the essence. Stablecoins run on blockchains that operate 24/7, allowing them to overcome this problem. Trading can take place around the clock, often with almost immediate settlement. This ensures that changing prices and foreign exchange rates don’t impact a trade.
How do stablecoins work?Stablecoins work by matching the price of the asset to which it’s pegged. They adjust their price by maintaining stocks of that asset as collateral, or through algorithms that adjust to fluctuations in demand and supply. Generally, stablecoins fall into the following categories:
- Collateral-backed stablecoins: cash or asset reserves act as collateral to prove that each coin is backed by its equivalent amount. These are also known as off-chain stablecoins
- Crypto-backed stablecoins: cryptocurrency reserves function as collateral to ensure a stablecoin maintains a one-to-one value with an asset. These are also known as on-chain stablecoins
- Algorithmic stablecoins: an algorithm maintains the peg between a stablecoin and an asset. It adds tokens to the supply if the price gets too high and removes them if the price falls below the peg