What Is a Stablecoin and How Does It Work?

A digital asset with a consistent price is known as a stablecoin. A stable-valued asset, such as a fiat money, a commodity, or another cryptocurrency, is what this cryptocurrency is linked to. Stablecoins are becoming more and more well-liked as a means of protecting oneself from the volatility of the cryptocurrency markets. In this post, we’ll look at what a stablecoin is, how they differ from one another, and how they operate.

An image of a coin with a hand steadying it, symbolizing a stablecoin's ability to remain stable.

A stablecoin: what is it?

Definition

A sort of digital asset called a stablecoin has a fixed price and is intended to do so. A stable-valued asset, such as a fiat money, a commodity, or another cryptocurrency, is what this cryptocurrency is linked to. Stablecoins are becoming more and more well-liked as a means of protecting oneself from the volatility of the cryptocurrency markets.

Stablecoins can be classified as either fiat-collateralized, crypto-collateralized, or non-collateralized.

Stablecoins Backed by Fiat

Stablecoins that have fiat collateral are supported by a fiat currency reserve. The coins are used to symbolize the amount of fiat currency held in reserve and each coin is backed by a reserve of fiat money, such as the U.S. dollar.

Overview

Stablecoins that have a fiat currency reserve backing them up are known as fiat-collateralized stablecoins. They are often tied to a fiat currency, like the US dollar or the euro, and issued by a controlled organization like a bank or firm. The quantity of fiat cash held in reserve is represented by the coins.

Process

The issuer initially places a reserve of fiat money into a bank account to generate a fiat-collateralized stablecoin. Then they develop a smart contract that generates tokens based on the amount of fiat money held in reserve. After that, the coins are made available to the general public for use as a means of exchange or for trading on exchanges.

Cryptocurrency-backed stablecoins

Stablecoins that have been crypto-collateralized are backed by a pool of digital currencies like Bitcoin or Ethereum. The coins are used to indicate the amount of bitcoin held in reserve and each coin is backed by a reserve of digital currencies.

Overview

Stablecoins that have a reserve of cryptocurrencies acting as collateral are known as crypto-collateralized stablecoins. They are often tied to a cryptocurrency like Bitcoin or Ethereum and issued by a decentralized entity like a blockchain network. The quantity of cryptocurrency held in reserve is represented by the coins.

Process

The issuer initially puts a reserve of cryptocurrencies into a wallet in order to produce a stablecoin with cryptocurrency backing. Then they develop a smart contract that distributes tokens based on the quantity of cryptocurrency held in reserve. After that, the coins are made available to the general public for use as a means of exchange or for trading on exchanges.

Stablecoins without Collateral

Stablecoins that are not collateralized by any kind of reserve asset are unbacked. Rather, they are stabilized by algorithms that change the amount of coins available to keep the price steady.

Overview

Stablecoins that are not collateralized by any kind of reserve asset are known as non-collateralized stablecoins. Rather, they are stabilized by algorithms that change the amount of coins available to keep the price steady. These currencies are often not tied to any assets and are created by a decentralized organization, such a blockchain network.

Process

The issuer initially develops a smart contract that issues tokens in order to produce a non-collateralized stablecoin. Then, in order to keep a steady price, they built up an algorithm that modifies the supply of coins. After that, the coins are made available to the general public for use as a means of exchange or for trading on exchanges.

A graph showing the price of a stablecoin compared to a volatile cryptocurrency.

Benefits and Drawbacks of Stablecoins Benefits

Stablecoins’ major benefit is that their price will remain consistent, making them useful as a means of trade or a store of wealth. Additionally, stablecoins may provide quicker transaction speeds and lower transaction fees than conventional payment networks.

Disadvantages

Stablecoins’ biggest drawback is that since they are not backed by any real assets, the issuer might manipulate them. Additionally, stablecoins lack the possibility of capital growth that other cryptocurrencies provide.

Conclusion

A sort of digital asset called a stablecoin is intended to keep its value stable. They provide a mechanism to protect against the volatility of the cryptocurrency markets and are backed by a reserve of fiat money, cryptocurrencies, or algorithmically adjusted supply. Compared to conventional payment networks, stablecoins have the potential to offer quicker transaction speeds and reduced transaction fees, but they are not without danger. Stablecoins are probably going to gain more and more traction as technology advances.

FAQ

A stablecoin: what is it?

A cryptocurrency known as a stablecoin is one that is intended to reduce the price volatility of the digital asset. To maintain a consistent value in comparison to a fiat currency, such the US dollar or the euro, stablecoins are created. Various assets, including fiat money, commodities, or other cryptocurrencies, are used to support stablecoins. Stablecoins are intended to be an alternative to conventional cryptocurrencies that is more dependable and stable.

The Function of a Stablecoin

Stablecoins are a more trustworthy type of digital money than other cryptocurrencies since they are meant to maintain a constant price in relation to a fiat currency. They are backed by a variety of assets, including fiat money, commodities, or other cryptocurrencies, to accomplish this. A fiat-collateralized stablecoin, which is backed by a fiat currency like the US Dollar, is the most popular sort of stablecoin. The backing asset is kept in a reserve under a third party’s management. The reserve is then put to use to guarantee that the supply of stablecoins is kept constant in relation to fiat money.

What Advantages Come with Using a Stablecoin?

Stablecoins offer a digital money that is more trustworthy than conventional cryptocurrencies. They may be used for payments, remittances, and trading without the danger of price volatility because they are created to maintain a constant price relative to a fiat currency. Stablecoins further provide lower fees, quicker transaction times than conventional payment systems, as well as an integrated security mechanism.

What kind of stablecoins are offered?

A fiat-collateralized stablecoin, which is backed by a fiat currency like the US Dollar, is the most popular sort of stablecoin. Crypto-collateralized stablecoins, which are backed by other cryptocurrencies, and non-collateralized stablecoins, which are not backed by any asset, are further varieties of stablecoins.

What Distinguishes Stablecoins from Other Cryptocurrencies?

A stablecoin is intended to have a stable price in relation to a fiat currency, whereas other cryptocurrencies are prone to price fluctuation. This is the major distinction between stablecoins and other cryptocurrencies. Stablecoins often provide cheaper costs and quicker transaction times than other cryptocurrencies as well.

How Can I Purchase a Stablecoin?

A number of exchanges, both controlled and decentralized exchanges and conventional crypto exchanges, provide stablecoins for sale. Stablecoins can also be bought straight from the organization that issued them.

Are Stablecoins Associated with Any Risks?

Stablecoins are intended to be more dependable than other cryptocurrencies, although they still carry significant hazards. For instance, market risk can apply to the reserve assets needed to support a stablecoin. Operational risk might also apply to the issuing firm.

Are Stablecoins Secure Enough?

Because stablecoins are frequently developed on top of already-existing blockchain networks like Ethereum, they are typically quite safe. This indicates that they gain from the distributed consensus and cryptographic encryption that are features of the blockchain network that are created for security. Some stablecoins also have built-in security features of their own.

How Should a Stablecoin Be Stored?

Stablecoins may be kept in a range of wallets, including as hardware wallets, desktop wallets, and mobile wallets. Selecting a wallet that works with the stablecoin you are using is crucial since not all wallets are compatible with all stablecoins.

Does Using a Stablecoin Come with Any Charges?

Yes, utilizing a stablecoin is frequently subject to fees. Depending on the stablecoin type and the platform you’re using, these costs may change. Generally speaking, costs are not too high in comparison to other payment options.