What are Stablecoins?

Electronic money is not a new concept. In actuality, it has been more than 150 years since Western Union made its first wire transfer in 1871. Since then, internet banking, credit, and debit cards have become commonplace for making cashless payments. Digital money, however, is not electronic money.

When you make a purchase through a smartphone app, it could feel as though you are using digital currency. The interaction between these systems and conventional banks' supply of central bank-issued paper money is only through communication.

In contrast, stablecoins are genuine digital currencies that are unique to the internet.

Purpose of Stablecoins

A large-cap cryptocurrency would need to be worth at least $500M in order to be less prone to price fluctuations. Since 2009, Bitcoin has been bringing cryptocurrencies into the mainstream. Since then, more than 10,000 new cryptocurrency coins have appeared.

However, only 131 of them—or a pitiful 1.26%—have a market valuation of more than $500 million. So, over 99% of the cryptocurrency market is vulnerable to large price movements, also known as volatility.

By being anchored to a fiat currency like the U.S. dollar, the primary reserve currency in the world, stablecoins offer market stability for cryptocurrencies.

Before stablecoins, cryptocurrency traders had to totally convert their holdings to fiat currency or risk suffering significant losses the next day.

After stablecoins, they can simply store blockchain assets in a wallet and engage in crypto trading as soon as the chance presents itself. Actually, stablecoin supply ratio (SSR) on cryptocurrency exchanges is frequently taken into account as a market indication.

Different Types of Stablecoins

1. Collateralized by Fiat

These are the most centralized stablecoins because companies are in charge of maintaining their collateral. After Tether (USDT), managed by Tether Limited, there is USD Coin (USDC), managed by Circle and Coinbase and other coins.

2. Collateralized by Other Cryptocurrencies

This is the case with one of the most popular decentralized stablecoins, DAI. Its origins stem from MakerDAO, a decentralized autonomous organization (DAO) ****on Ethereum blockchain, serving as a decentralized blockchain treasury.

Through the use of smart contracts called Collateralized Debt Positions (CDPs), DAI stablecoins are backed by locked-in ETH, BAT, and other cryptocurrencies.

3. Collateralized by an Algorithmic Ecosystem

Algorithm-based stablecoins come in the final category and do not have any associated collateral. Therefore, they are also referred to as non-collateralized stablecoins.

The algorithm or the protocol is backing up these stablecoins works as the ‘central bank.’ It helps in increasing the supply in event of the deflationary tendency of the token or reducing the supply in event of a decline in purchasing power of stablecoin.

4. Collateralized by Commodities

Outside of cash, crypto coins, and burning mechanics, stablecoins are collateralized by commodities — oil, gas, minerals. One of the most common minerals for this purpose is gold.

Thanks to its scarcity, gold derives value, making it a suitable stable collateral.

Future of Stablecoins

The future of finance may be determined by digital money, as stablecoins have demonstrably shown. Stablecoins have evolved into the native currency of the Internet, integrated into the crypto ecosystem, just as data freely roams the Internet.

Therefore, it is even possible to claim that stablecoins already fulfil the function of CBDCs, or central bank digital currencies. Stablecoins are not governed by central banks, thus it is unclear whether there will be room for them after more CBDCs go live in the upcoming years.