What is Stablecoin?

Cryptocurrencies have swept the globe since the launch of Bitcoin and later Ethereum. Although cryptocurrency tokens were initially intended to be used for particular purposes, many utility tokens that were introduced to the market did not adhere to this standard. Buyers started to view cryptocurrencies and tokens as investments as they started to become volatile. Therefore, a solution to the issue of bitcoin volatility was required. Stablecoins, a type of token that combines the best characteristics of cryptocurrencies with the stability of FIAT currency, became popular as a result of this.

Stablecoins can connect the worlds of cryptocurrencies and fiat money since their prices are linked to a reserve asset like the US dollar or gold. Comparing this to Bitcoin, the volatility is greatly reduced. Additionally, it produces a digital money that can be used for anything, including everyday transactions and transfers between exchanges.

Today, the United Nations has approved nearly 200 currencies, including the US dollar, the European Union's Euro, the Japanese Yen, and more. In all major economies around the world, these currencies are frequently used to pay for products and services. The value of these currencies is subject to a little daily shift despite inflation, fluctuating exchange rates, and other variables. It makes it possible for various economies to run solely on the use of these government-issued moneys. For instance, you could pay $4 for a loaf of bread from your favourite bakery today while knowing that its price is unlikely to drop dramatically the next day to just 99 cents.

In this article, we will discuss stablecoins in detail, including the process of how to create them.

What is Stablecoin?

A cryptocurrency whose value is linked to another coin, good, or financial instrument is known as a stablecoin. Stablecoins are intended to provide an alternative to cryptocurrencies' extreme volatility, which makes them less suitable as investments for everyday transactions.

Stablecoin, to put it simply, is a type of digital currency meant to resemble established, reliable currencies. A cryptocurrency that is collateralized to the value of an underlying asset is known as a stablecoin.

Many stablecoins are backed at a 1:1 ratio by certain fiat currencies that can be traded on exchanges, like the US dollar or the euro. Additionally, stablecoins can be linked to other types of assets, such as other cryptocurrencies or precious commodities like gold.

Stablecoins, in contrast to other cryptocurrencies, do not deal with the problems of excessive volatility. They take use of fiat currency's reliability and stability while gaining the advantages of cryptocurrencies, including as immutability, transparency, security, quick transactions, digital wallets, privacy, and cheap costs.

What are the types of Stablecoin?

The following types are the most common categories for stablecoins:

Collateralized stablecoins

Stablecoins that have particular collateral backing their values are known as collateralized stablecoins. They are further divided into:

Fiat-backed stablecoins 

Stablecoins backed by fiat money are indexed to the value of fiat money. Tether (USDT), which introduced the idea of a cryptocurrency linked to the value of the US dollar and supported by reserves representing the whole market capitalization, was the first fiat-backed stablecoin. The USD coin and PAXOS Standard are two other instances of fiat-backed stablecoins.

Asset-backed stablecoins

Instead of being backed by cryptocurrencies or fiat, asset-backed stablecoins are backed by other assets. Tokens with an asset backing are indexed to the value of assets like gold, silver, diamonds, oil, real estate, and many others.

Crypto-backed stablecoins

Stablecoins backed by cryptocurrencies employ methods to ensure that their value does not fluctuate with the price of the underlying token. A stablecoin backed by cryptocurrency and tied to the value of the US dollar, DAI token is supported by Ether. By using a Maker Smart Contract that makes and destroys MKR tokens in response to changes in the price of ETH, it is able to retain its current pricing.

Stablecoins without collateral

Non-collateralized stablecoins, also referred to as Seigniorage shares or algorithmic stablecoins, embody the fundamental idea behind cryptocurrencies: decentralisation. The idea of non-collateralized stablecoins has gained attention since many crypto fans have claimed that stablecoins should be centred on an asset but employ algorithms to derive value.

Non-collateralized stablecoins' financial strength is determined by a formula based on supply and demand rather than a single entity. One example of algorithmic stablecoins that attracted a lot of attention is Basis, which garnered $133 million from Bain Capital Ventures, Polychain Capital, and GV.

Algorithmic stablecoins

Reserve assets may be contained in algorithmic stablecoins. The main distinction is how they use an algorithm to limit supply in order to maintain a consistent price for the stable coin. In essence, this is a computer programme that executes a predetermined formula.

This is similar to central banks, which do not rely on a reserve asset to maintain the stability of the currency's value. It is crucial to remember that a central bank like the U.S. Federal Reserve publicly sets monetary policy based on accepted guidelines. Credibility is increased by the fact that it is both the issuer and the bearer of legal tender.