What are stablecoins?
Stablecoins are a type of cryptocurrency whose main role is to hold value, or some stable price. Unlike traditional cryptocurrencies, such as Bitcoin and Ethereum, which can be extremely volatile, stablecoins are designed to maintain a constant value tied to a specific reference asset, such as the US dollar or gold. They function by using various mechanisms, including fiat currency reserves, cryptocurrencies or algorithms, to ensure that their market value remains stable. The application of stablecoins is wide and varied. They are most often used in trading on crypto exchanges to avoid large price fluctuations when buying and selling other cryptocurrencies. Also, due to their stability, they are popular for sending international transactions, as they enable fast transfer of funds with minimal costs and without the risk of losing value during the transaction, as with e.g. Bitcoin. So what are all the types of stablecoins, which is the most popular and reliable stablecoin and many other questions we study and explain in today’s blog.
Source: cointelegraph
What types of stablecoins are there?
Stablecoins can be categorized according to the type of asset that ensures their stability. There are three main types:
- Stablecoins with reserves in fiat currencies: they are backed by direct reserves of fiat currencies such as the US dollar or the euro. For every stablecoin issued, there is an equivalent amount of fiat currency stored in a bank or with a third party as collateral. Examples include USDC and Tether (USDT).
- Cryptocurrency Backed Stablecoins: These stablecoins use other cryptocurrencies as collateral. To maintain stability, the amount of cryptocurrency backing a stablecoin is usually greater than the value of the stablecoin itself, which is called over-collateralization. For example it takes $3,000 of collateral to create $1,500 of stablecoin, and the best example of a stablecoin that uses this mechanism is DAI.
- Algorithmic stablecoins: use complex algorithms to automatically adjust the supply in circulation to keep the price close to a target value. They do not use traditional reserves, but instead rely on mathematical and financial models to maintain stability. Examples include Ampleforth (AMPL) and TerraUSD (pre-collapse).
Source: cointelegraph
Stablecoins with reserves in fiat currencies
Stablecoins with reserves in fiat currencies are the most well-known form of stablecoin on the market. Tether (USDT) and Circle’s USD Coin (USDC) are the two most famous examples of this type. They are backed by direct reserves in fiat currencies, meaning that for every stablecoin issued, there is a corresponding amount in a currency such as the US dollar held in a bank or with third parties. The advantages of such stablecoins include high liquidity and wide acceptance in the markets, which facilitates trading and transactions. However, there are also disadvantages. Reliance on reserves in fiat currencies means that stablecoins are subject to the same economic changes that affect those currencies, the best example of this flaw was the bankruptcy of the bank where Circle kept a large amount of its money. USDC lost its connection for a few days, and was worth less than one dollar, but eventually it was announced that the bank would be bought by the state, and that the funds would be returned to the users, so the price of USDC returned to one dollar. Also, there is a risk of centralization, i.e. the need to trust the stablecoin issuer to maintain adequate reserves that it guarantees to hold.
Source: cointelegraph
Stablecoins with cryptocurrency reserves
Cryptocurrency-backed stablecoins are innovative financial instruments that use other cryptocurrencies as collateral to maintain their value. MakerDAO’s DAI is one of the most famous examples of this type of stablecoin, which uses Ethereum and other cryptocurrencies as collateral to issue DAI. The advantages of such stablecoins include greater decentralization and resistance to censorship, as they do not rely on centralized institutions to maintain reserves. Also, they allow users to retain ownership of their collateral, while simultaneously using the derived stablecoins for transactions or savings. However, disadvantages include the complexity and potential risks associated with the volatility of cryptocurrencies that serve as collateral. If the value of the collateral drops sharply, it may lead to the liquidation of the user’s collateral in order to maintain the stability of the stablecoin. In addition, users must understand mechanisms such as liquidation ratios and maintaining adequate collateral levels, which can be challenging for those unfamiliar with the crypto economy. What this type of stablecoin needs is a simpler approach than the traditional one, to make it easier for new users to understand and use this type of stablecoin.
Source: cointelegraph
Algorithmic stablecoins
Algorithmic stablecoins are a special category of digital currencies that use software algorithms to maintain a stable value, usually tied to a fiat currency like the dollar. Terra Luna’s UST (TerraUSD) was one of the most well-known algorithmic stablecoins, but it collapsed due to a series of factors that included a loss of investor confidence, mass selling, and the failure of the mechanisms that were supposed to maintain its peg to the dollar. The advantages of algorithmic stablecoins lie in their decentralization and flexibility. They do not require traditional reserves, but instead rely on programmed economic models to automatically adjust supply, which can be less expensive and more scalable. This allowed UST to reach a value of over 50 billion US dollars in just a few months. However, the disadvantages turned out to be more significant. Algorithmic stablecoins are highly experimental and can be extremely risky. The collapse of TerraUSD illustrates the potential instability of this approach, where the mechanisms that are supposed to ensure stability fail under conditions of extreme market stress. This leads to rapid and dramatic losses in value, which can result in significant financial losses. In the Terra Luna example, several billion dollars were completely gone in just a few days.
Tether (USDT) ranks as the largest stablecoin on the market, with operations dating back to 2014. years. This stablecoin has become a fundamental part of the crypto ecosystem, providing a key infrastructure for trading. In 2023 In 2018, Tether made an impressive profit of $6.2 billion, reflecting its widespread acceptance and trust among users. With more than 100 billion dollars in USDT in circulation, Tether represents the largest, and quite possibly the most reliable stablecoin of all, but of course no one guarantees that it will remain so in the future.
Source: cointelegraph
Conclusion
In today’s blog, we tackled the topic of stablecoins. We explained what stablecoins are, listed some of the most popular types of stablecoins, and briefly explained how they work technically. We have presented you with the most popular stablecoins in each of these types, and as usual listed the advantages and disadvantages of each type. We specifically mentioned Tether, which in 2023. achieved record profits, and in 2024 we can expect another record year, so this cryptocurrency area will definitely remain interesting to watch in the coming years. We hope you enjoyed and learned something new, if you have any questions feel free to contact us on our social networks ( Twitter , Instagram ).
