What Are Stablecoins? Definition, How They Work, Types
The biggest example in this category is the DAI (DAI) algorithmic stablecoin, which is pegged to the U.S. dollar but is backed by Ethereum and other cryptocurrencies. Fiat currencies, such as the U.S. dollar or the British pound, don’t see this level of price volatility. So another way to think about stablecoins is as a tokenized version of a fiat currency. In theory, a U.S. dollar-based stablecoin is a token that will reside the latest cryptocurrencies news for investment advisers and wealth managers on a blockchain and always trade for one dollar.
What is legal tender?
At a market cap of $66.9 billion, USDT is currently the third biggest cryptocurrency, behind Bitcoin and Ethereum (ETH). However, it has been besieged by doubt around the reliability of its reserves for years. USDC is a stablecoin outlier in disclosing precise data regarding its assets and liabilities. There has long been controversy about the reliability of the collateralizing reserves regarding certain stablecoins (i.e., that the stablecoin’s liabilities are higher than its reserves). However, in practice, few, if any, stablecoins meet these assumptions. Currently, stablecoin regulations are still up for discussion in most jurisdictions.
As the name implies, stablecoins aim to address this problem by promising to hold the value of the cryptocurrency steady in a variety of ways. Though Bitcoin remains the most popular cryptocurrency, it tends to suffer from high volatility in its price, or exchange rate. For instance, Bitcoin’s price rose from just under $5,000 in March 2020 to over $63,000 in April 2021, only to plunge almost 50% over the next two months.
USD Coin (USDC)
First, crypto-backed stablecoins are often run by decentralized companies or organizations through smart contracts. A stablecoin is a cryptocurrency whose value is “pegged” (meaning tied) to another asset—often a traditional fiat currency like the US dollar. For example, one unit of a stablecoin that’s pegged to the US dollar should always be worth $1. Serving the purpose of maintaining value and purchasing power, pegging against an asset can make stablecoins more resilient to market fluctuations in the cryptocurrency space.
Others are skeptical, noting that they’ve played major roles in how to sell your bitcoin from wallet exodus buy bitcoin to transfer 2021 the collapse of several cryptocurrencies and crypto institutions. Collateralized stablecoins maintain a pool of collateral to support the coin’s value. Whenever the holder of a stablecoin wishes to cash out their tokens, an equal amount of the collateralizing assets is taken from the reserves. These benefits make stablecoins more competitive than other cryptocurrencies, as they relieve a number of consumer and business pain points.
- As of writing this article, the stablecoin market is worth nearly 140 billion U.S. dollars.
- Unlike other stablecoins, DAI is decentralized and uses smart contracts and incentives as the mechanism to maintain its peg.
- Following that, they’ll use the stablecoin to execute a trade for another cryptocurrency, say BTC or CRO.
- But, because stablecoins have a stable value, people may start using them more to pay for a wider range of things.
- A stablecoin is a cryptocurrency that is designed to make transacting with crypto more practical.
Such reserves are maintained by independent custodians and are regularly audited, something that should be considered cautiously. Tether (USDT) and TrueUSD (TUSD) are popular stablecoins backed by U.S. dollar reserves and denominated at parity to the dollar. As of late June 2024, Tether (USDT) was the third-largest cryptocurrency by market capitalization, worth more than $112 billion. Some would argue that stablecoins are a solution in search of a problem, given the wide availability and acceptance of the U.S. dollar.
It’s an important way to avoid large disruption to the UK’s financial system and economy. A stablecoin typically goes through a few stages before someone can use it. In addition, the Crypto.com Exchange is distinct from the Crypto.com Main App, and the availability of products and services on the Crypto.com Exchange is subject to jurisdictional limits. Before accessing the Crypto.com Exchange, please refer to the following link and ensure that you are not in any geo-restricted jurisdictions. The comments, opinions, and analyses expressed on Investopedia are for informational purposes only. As of the date this article was written, the author does not own cryptocurrency.
Is Stablecoin a Bitcoin?
If the price falls below $1, the algorithm “burns,” or removes, coins from circulation to increase its price. Somewhat of a sub-category of fiat-collateralized coins, commodity-backed stablecoins are cryptocurrencies that are pegged to the market value of commodities such as gold, silver, or oil. These stablecoins generally hold the commodity using third-party custodians or by investing in instruments that hold them.
For example, the reserve of a fiat-backed stablecoin like USDC may contain $1 million in U.S. dollars to serve as collateral for a million USDC. Commodity-backed stablecoins are cryptocurrencies that use commodities such as gold, real estate or metals as collateral to how to buy juno crypto provide their stability. Of these, gold is generally the most popular commodity used as collateral for commodity-backed stablecoins. Instead of fiat currencies, however, they’re pegged to commodities—typically gold.
However, due to their uncollateralised nature and reliance on algorithms to maintain the peg of an asset, they are broadly considered inherently more vulnerable to the risk of depegging. Algorithmic stablecoins are the outlier in that they do not use any form of collateral to achieve their stability. Instead, these stablecoins achieve their price stability by using algorithms to control the supply and circulation of their tokens on the marketplace. These stablecoins will issue new tokens when the price of stablecoins goes above the target price or above the fiat currency it is tracking.
Consult an attorney or tax professional regarding your specific situation. Although not to the same extent as TerraUSD, investors worried about the reliability of reserves, and whether Tether was fully collateralized. But due to the underlying collateral being in cryptocurrency, it is prone to more volatility.
Any individual with internet access can use stablecoins to transact daily. Conventionally, this would require foreign exchange (FX) conversions with multiple banks and intermediaries. This route would then involve a series of steps and various fees and often take a few business days to complete, as opposed to a stablecoin transfer which would be instant and come with low, or zero, fees. Tether still maintains that it has sufficient reserves to back the $66.9 billion of Tether tokens in circulation. Additionally, the company has yet to default on any redemption request.
There Are Four Types of Stablecoins:
If the market price of the stablecoin falls below the price of the fiat currency it tracks, token supply is reduced. If the price of the stablecoin rises above the price of its pegged fiat currency, the algorithm increases token supply to put downward pressure on the stablecoin value. Stablecoins attempt to peg their market value to some external reference, usually a fiat currency. They are more useful than volatile cryptocurrencies as a medium of exchange. Stablecoins may be pegged to a currency like the U.S. dollar, the price of a commodity such as gold, or use an algorithm to control supply. They also maintain reserve assets as collateral or through algorithmic formulas that are supposed to control supply.
These utility benefits may include fast and straightforward international money transfers without the expensive fees charged by banks. Rather than watching the fiat currency value of cryptocurrencies fluctuate while deciding on the next trade, stablecoins offer a way to ensure a purchase holds roughly the same value between trades. While this is a great shelter from volatility, it’s upside is capped at that of the pegged asset. Users may be protected from sharp decreases in value for the most part, but they can’t expect much in the way of increased returns, either. Instead of using reserve systems or backed assets, algorithmic stablecoins use a fully algorithmic approach to adjust their supply in response to price fluctuations.
CBDCs are issued by a country’s central bank and can be thought of like a digital banknote. They are like a digital representation of the cash you already use. Central banks work to keep the value of the money they issue stable. Prior to the event, the TerraUSD project was widely regarded by crypto enthusiasts as one of the most exciting stablecoin innovations. Its demise created a domino effect in the industry, bringing down multiple crypto institutions that had assets stored in UST and accelerating a downturn in the crypto market. A stablecoin is a type of cryptocurrency whose value should tie to another relatively “stable” asset like the U.S. dollar, euro, or gold.
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