Cryptocurrencies are known for high volatility. However, stablecoins (which are a form of cryptocurrency) allow those who want to avoid volatility while still staying in the crypto market. The purpose of a stable coin is to retain a peg to the price of a fiat currency, a commodity, or some other asset. Stablecoins are meant to maintain a predictable value.
What are the main types of digital stablecoins?
There are four main Stablecoin collateral structures: Fiat-backed stable coin, Crypto-backed stable coins, Commodity-backed stable coin and Algorithmic stable coin.
Fiat-backed stablecoins are digital assets that derive their value from being backed by a fiat currency held in reserve. The most popular fiat-backed stablecoin is Tether (USDT), which is pegged to the US dollar. Other popular fiat-backed stablecoins include TrueUSD (TUSD), USD Coin (USDC), and Paxos Standard Token (PAX). There are also other stablecoins that are pegged to other fiat currencies like the Euro (EUR) or the Japanese Yen (JPY).
Crypto-backed stablecoins are digital assets that derive their value from being backed by a cryptocurrency held in reserve. The most popular crypto-backed stablecoin is DAI, which is pegged to the value of Ethereum (ETH).
Commodity-backed stablecoins are collateralized using physical assets like precious metals, oil, and real estate. The most popular commodity to be collateralized is gold; Tether Gold (XAUT) and Paxos Gold (PAXG) are two of the most liquid gold-backed stablecoins pegged to the price of gold.
Algorithmic stablecoins are digital assets that derive their value from being backed by an on-chain algorithm. Algorithmic stablecoins are not backed by any assets but are instead stabilized by algorithms that facilitate a change in supply and demand between the stablecoin and another cryptocurrency that backs the stablecoins. The algorithm or the smart contract regulates the relationship between the two. Examples of algorithmic stablecoins are MIM, FRAX etc.
Benefits of stablecoins?
The main benefit of stablecoins is that they offer a way to store value in the cryptocurrency market without the volatility that is typically associated with digital assets. This makes stablecoins ideal for use cases such as payments, remittances, and savings.
The important difference between stablecoins and regular cryptocurrencies is that stablecoins are designed to be stable, while regular cryptocurrencies are not. This stability is achieved through different mechanisms, such as being backed by assets or stabilized by algorithms.
It’s important to understand the risks associated with stablecoins that are not fiat-backed. The different types of collateral structures have different risk structures. As an investor or trader, it’s crucial to be aware of those differences before making any investment.
Disclaimer: Cryptocurrency investment is subject to high market risk. The statements made in this article are for educational purposes only and should not be considered financial advice or an investment recommendation.
