What Is A Stablecoin?
What is a stablecoin?
As mediums of exchange, cryptocurrencies are excellent from a technological standpoint. However, the fluctuations in their value have ultimately rendered them highly risky investments, and not ideal for making payments. By the time a transaction settles, coins can be worth significantly more or less than they were at the time they were sent.
But stablecoins have no such problem. These assets see negligible price movement and closely track the value of the underlying asset or fiat currency that they emulate. As such, they serve as reliable safe-haven assets amid volatile markets.
There are a number of ways in which a stablecoin can maintain its stability. In this article, we’ll discuss some of the mechanisms used, their advantages, and their limitations.
How do stablecoins work?
There are a few categories of stablecoins, each of which goes about pegging their units in different ways. Below are some of the most common types of stablecoin.
The most popular kind of stablecoin is that which is directly backed by fiat currency with a 1:1 ratio. We also call these fiat-collateralized stablecoins. A central issuer (or bank) holds an amount of fiat currency in reserve and issues a proportionate amount of tokens.
For instance, the issuer may hold one million dollars, and distribute one million tokens worth a dollar each. Users can freely trade these as they would do with tokens or cryptocurrencies, and at any time, the holders can redeem them for their equivalent in USD.
To acquire this kind of stablecoin, users lock their cryptocurrency into a contract, which issues the token. Later, to get their collateral back, they pay stablecoins back into the same contract (along with any interest).
Stablecoins use cases
This list is far from exhaustive. The market for stable digital currencies is broad, something evidenced by the proliferation of hundreds of stablecoin projects.
Stablecoins pros and cons
Although they have some disadvantages, stablecoins are a critical component of the cryptocurrency markets. Through a variety of mechanisms, these digital currencies can remain more or less steady at set prices. This allows them to be used reliably not only as mediums of exchange, but as a safe haven for traders and investors.