Stablecoins are the cornerstone of the crypto. They are an important aspect of DeFi, as they represent the liquidity that’s currently circulating in the market.
In this article, we’ll give you all the information about what stablecoins are and how they work in crypto and Web3. Enjoy!
What is a Stablecoin?
Stablecoins are a type of cryptocurrency designed to maintain a stable value by being tied to another asset, like the U.S. dollar or euro. This means one stablecoin usually equals one unit of the asset it’s pegged to, making it less volatile than other cryptocurrencies.
Most stablecoins are backed by real assets. For example, if an organization issues 100 million stablecoins, it might hold $100 million in a bank as a reserve. This reserve ensures that each stablecoin can be exchanged for its equivalent value.
Some stablecoins, known as algorithmic stablecoins, aren’t backed by assets. Instead, they use technical methods to maintain their value. These can be riskier than asset-backed stablecoins.
In contrast to other cryptocurrencies like Bitcoin, which fluctuate in value, stablecoins aim to stay consistent. This stability makes them useful for transactions, trading, and bridging the gap between traditional finance and the crypto world.
Types of Stablecoins
There are four main types of stablecoins, each with different ways of maintaining their value:
Fiat-Collateralized Stablecoins
These stablecoins are backed by traditional currencies like the USD or EUR at a 1:1 ratio. For each stablecoin issued, there’s an equal amount of fiat currency held in reserve.
They’re simple to understand and have low volatility but rely on a central authority to manage the reserves, which makes them vulnerable to hacks and counterparty risks.
Crypto-Backed Stablecoins
These use cryptocurrencies as collateral instead of fiat. They’re decentralized and don’t need a custodian, but they’re more complex.
Because of crypto’s volatility, more crypto is locked as collateral than the value of the stablecoins issued. This method avoids centralization but is riskier due to dependency on the crypto’s value.
Non-Collateralized (Algorithmic) Stablecoins
These stablecoins use algorithms to control their supply, keeping their value stable without any collateral. They’re decentralized and rely on smart contracts but are complex and have historically struggled to maintain their peg.
Commodity-Backed Stablecoins
These are backed by physical assets like gold, real estate, or oil. They offer stability and liquidity but are centralized and require audits to verify their backing.
Why Are Stablecoins Important?
Stablecoins play an important role in crypto trading because they offer price stability, unlike most cryptocurrencies. While coins like Bitcoin and Ethereum often experience big price swings, stablecoins keep their value steady by linking to a fixed asset, like the U.S. dollar. This makes stablecoins practical for real transactions and allows traders to avoid the risks of volatility.
For example, traders often convert their crypto holdings into stablecoins, such as Tether, instead of converting them into dollars. This process is quicker and accessible 24/7, unlike banks that close overnight and on weekends.
Additionally, stablecoins work well with smart contracts — digital agreements that execute automatically when certain conditions are met. Since stablecoins maintain a stable value, they help prevent disputes that could arise with more volatile cryptocurrencies. This makes trading smoother and more predictable, contributing to their popularity in the crypto market.
Top 3 Most Valuable Stablecoins
The top three most valuable stablecoins are Tether (USDT), USD Coin (USDC), and Dai (DAI). Here’s a quick look at each:
Tether
Launched in 2014, Tether is the oldest and most popular stablecoin. It’s widely used for transferring money between exchanges quickly, especially for arbitrage opportunities.
Chinese importers in Russia have also used it to bypass capital controls in China. However, Tether faced legal issues with the New York Attorney General, settling the case in 2021 by paying $18.5 million and agreeing to provide regular reports on its reserves.
USD Coin
USD Coin was introduced in 2018 by Circle and Coinbase through the Centre Consortium. It’s pegged to the U.S. dollar and operates on an open-source protocol, allowing others to create their products with it.
As of 2024, Circle independently mints USDC and is looking to go public, raising its credibility and authority on the market.
Dai
Dai is a crypto-collateralized stablecoin issued by MakerDAO on Ethereum and other blockchains.
Unlike other stablecoins, Dai aims to be decentralized, with Ethereum smart contracts handling its stability.
The stablecoin is minted by MakerDAO after users agree to lock some crypto assets and receive the equivalent in Dai stablecoins.
Conclusion
In conclusion, stablecoins offer much-needed stability in the volatile world of cryptocurrencies. They provide a safer way to trade and invest, making them popular for many users.
However, issues like market crashes, regulatory changes, or problems with reserves could affect their value. Therefore, while stablecoins are valuable for traders and investors, always be aware of their potential risks, especially in uncertain times.