What are stablecoins and how do they work?

Many people might think that stablecoins are a digital currency that is pegged to dollar = digital dollar. That’s not exactly true. There are four different types of stablecoins and they can be tied to any fiat currency like the Australian dollar, or euro, and even to different forms of physical assets, like gold. Let’s dig in a little bit deeper to get closer to all the types of stablecoins.?

Four Types of Stablecoins

Fiat-backed stablecoins

This type of stablecoins is the most popular one on the market: it is pegged to the US dollar at a 1:1 ratio. There are also stablecoins that are backed by the euro, Australian dollar, and other fiat currencies.?The most popular ones on the market are USDT and USDC stablecoins which are pegged to the U.S. dollar on a 1:1 basis.

Commodity-backed stablecoins

Commodity-backed stablecoins are pegged to the value of commodities like oil, precious metal (gold, silver), or real estate. Tether Gold (XAUT) is a great example of a commodity-backed stablecoin: it is backed by a reserve of gold kept inside a vault in Switzerland. One ounce of gold is equal to one XAUT.

Algorithmic stablecoins

Algorithmic stablecoins use special algorithms to automatically burn or mint new coins in order to modulate it simply based on their demand on the market.?

An example of the algorithmic stablecoin is Terra’s UST. The algorithm itself is quite complex and difficult to implement. This is what we saw less than a day ago when UST stablecoin lost the dollar peg, dropping to the level of $0.68 per token.

Cryptocurrency-backed stablecoins

Cryptocurrency-backed stablecoins are pegged to the price of another more established cryptocurrency. A crypto-backed stablecoin can be issued to launch one asset on a different blockchain. For example, Wrapped Bitcoin (WBTC) is a stablecoin backed by Bitcoin on the Ethereum blockchain.

What are the advantages of stablecoins?

There are several advantages of stablecoins over fiat and other cryptocurrencies.?As we all know, the crypto market is volatile.

• So, the first advantage is their stability. What I mean is that they are more transparent and secure versions of fiat currency functioning on the blockchain.
• The second advantage of stablecoins is that they are much cheaper and faster to make transactions.
• One more plus is that stablecoins offer higher yields than savings accounts: from 6-10% compared to the average of 0.5% in banks.
• Also, commodity-backed stablecoins make precious metals easy to carry. For example, gold can be used as a medium of exchange through these stablecoins and can even be lent out to earn interest.

Summing up, stablecoins are a great opportunity to protect your portfolio from volatility in the cryptocurrency market. Having some stablecoins makes it easier for you to buy a more cheap cryptocurrency when the market falls.?

*this article is not financial advice and is written for educational purposes only.?