Understanding Stablecoins

?? Welcome Back to Crypto Unlocked: Understanding Stablecoins!

Hello everyone! Welcome to the eighth instalment of Crypto Unlocked. Today, we’re going to explore the fascinating world of stablecoins. We'll look at what they are, how they work, and why they are a crucial part of the cryptocurrency ecosystem.

?? What Are Stablecoins?

Stablecoins are a type of cryptocurrency designed to minimize price volatility. Unlike traditional cryptocurrencies like Bitcoin or Ethereum, whose prices can fluctuate significantly, stablecoins aim to maintain a stable value. They achieve this stability by being pegged to a reserve of assets, often fiat currencies like the US Dollar or Euro, commodities like gold, or even other cryptocurrencies.

?? Types of Stablecoins:

1.??? Fiat-Collateralised Stablecoins: These stablecoins are backed by fiat currencies in a 1:1 ratio. For every stablecoin issued, an equivalent amount of fiat currency is held in reserve. Popular examples include Tether (USDT) and USD Coin (USDC).

2.??? Commodity-Collateralised Stablecoins: These stablecoins are backed by physical assets such as precious metals e.g. Paxos Gold (PAXG)

3.??? Crypto-Collateralised Stablecoins: These stablecoins are backed by other cryptocurrencies and often over-collateralised to account for the volatility of crypto assets e.g. Dai (DAI)

4.??? Algorithmic Stablecoins: These stablecoins maintain their peg using algorithms and smart contracts that automatically adjust the supply based on market demand. Examples include Frax (FRAX), USDe (Ethena) and UST (Terra USD)

o??? Cautionary Tale: Algorithmic stablecoins can be risky. A notable example is the collapse of UST/Luna. Terra USD (UST) was an algorithmic stablecoin pegged to the U.S. dollar, while Luna was its sister token used to maintain this peg through a mint-and-burn mechanism. At the time of its collapse in May 2022, Terra USD (UST) had a market cap of approximately $18 billion, while Luna's market cap was around $40 billion. UST dramatically lost its peg to the dollar, leading to a hyperinflationary spiral in Luna, causing tens of billions in losses in the market.

?? Popular Stablecoins:

• Tether (USDT): One of the most widely used stablecoins, USDT is pegged to the U.S. dollar and used extensively for trading and transactions in the crypto space with a market cap of over $100 billion. USDT is backed by a combination of reserves including cash, cash equivalents, and other assets, with regular reports detailing its reserves.
• USD Coin (USDC): Another popular stablecoin, USDC is fully backed by U.S. dollars held in reserve and regularly audited for transparency with a market cap of over $30 billion. USDC is fully backed by U.S. dollars held in reserve, audited monthly for transparency.
• Paxos Gold (PAXG): Each PAXG token is backed by one fine troy ounce of a London Good Delivery gold bar, stored in professional vault facilities. This type of stablecoin offers the stability of gold prices in a digital asset format, with a market cap of $450 million.
• Dai (DAI): A decentralised stablecoin on the Ethereum blockchain, DAI maintains its peg to the U.S. dollar through crypto collateral and the MakerDAO system and has a market cap of $5 billion. DAI is backed by a diversified pool of crypto assets managed by the MakerDAO protocol.
• USDe (Ethena): A new and innovative algorithmic stablecoin on the Ethereum blockchain, USDe aims to maintain stability through advanced economic models, leveraging delta hedging derivatives positions against protocol-held collateral and a mint and redeem arbitrage mechanism, with a market cap of $800 million.
• Frax (FRAX): The first fractional-algorithmic stablecoin, Frax is partially backed by collateral and partially stabilised through algorithmic mechanisms with a market cap of $650 million.

?? How Do Stablecoins Work?

1.??? Fiat-Collateralised: These stablecoins maintain stability by holding fiat currency reserves equivalent to the amount of stablecoins issued. Regular audits ensure that reserves match the circulating supply.

2.??? Crypto-Collateralised: These stablecoins use smart contracts to lock up crypto assets as collateral. The collateralisation ratio is higher to account for the volatility of crypto assets. If the value of the collateral falls, more assets can be added to maintain stability.

3.??? Algorithmic: These stablecoins use algorithms and smart contracts to manage the supply of the stablecoin. If the stablecoin's price deviates from its peg, the algorithm adjusts the supply by minting or burning tokens to restore stability.

?? Why Are Stablecoins Important?

• Price Stability: Stablecoins offer the stability of fiat currencies with the advantages of cryptocurrencies, making them ideal for transactions, savings, and trading.
• Cross-Border Transactions: They facilitate quick and low-cost international transactions without the need for traditional banking systems.
• Decentralised Finance (DeFi): Stablecoins are crucial in the DeFi ecosystem, providing a stable medium of exchange, collateral for loans, and a hedge against volatility.
• Financial Inclusion: Stablecoins enable access to financial services for people in regions with unstable local currencies or limited banking infrastructure.

?? Stay Tuned for More!

Join us every Tuesday and Friday as we continue to explore the world of cryptocurrencies and blockchain technology. In our next post, we'll delve into the revolutionary world of Decentralised Finance (DeFi) and its impact on the financial ecosystem.

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?? Disclaimer

Please note this is not financial advice. The content shared in this series is for educational purposes only. Always do your own research or consult with a professional before making any financial decisions.

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