What sets Stablecoin apart from other cryptocurrencies is its direct tie to fiat currency. Fiat currency is printed money such as Euros, Dollars, or exchange-traded commodities such as gold.
We are already used to the credit system for fiat money, but with less autonomy and privacy as cryptocurrency. Stablecoin is the bridge between fiat money and cryptocurrency. The concept of cryptocurrency is a little easier to grasp for some making Stablecoin more inclusive than other cryptocurrencies such as Ethereum and Bitcoin.
How Does It Work?
Cryptocurrencies are often volatile and experience short-term fluctuations in value. Unlike other cryptocurrencies that are treated as an investment opportunity rather than a currency, Stablecoins aim for day-to-day use like buying milk or a pair of jeans.
Much like fiat money, whether you physically possess your money or keep it in your bank account, Stablecoin does not fluctuate in value as often as other cryptocurrencies. This means that Stablecoin can have its value linked to any commodity or currency. They are commonly pegged to fiat currency more than anything else. If someone tells you they have Stablecoins, they are most likely saying they have fiat currency coins.
Even if Stablecoin value fluctuates, it does for a short period in a tiny amount but then returns to its original value.
Types of Stablecoin
As the demand for alternative digital currencies increases, so do the types of Stablecoin. There are three main types:
- Fiat money backed centralized coins
- Cryptocurrency back decentralized coins
- Decentralized algorithmic coins
Coins that adopt a centralized model and back the issue of new tokens with fiat cash at a 1:1 ratio dominate the Stablecoin market. Stablecoins like Tether (USDT) and USD Coin (USDC) are examples of this class.
Other coins, such as DAI, an ERC20 token on the Ethereum blockchain, are newer, but their decentralized format has helped them acquire popularity.
Users can apply cryptocurrency as collateral to borrow DAI cryptocurrency on the Maker Decentralized Autonomous Organization (DAO) platform, rather than relying on fiat reserves to keep their value stable. DAI is controlled by network consensus rather than a centralized team, and it has a value of one dollar.
Decentralized algorithmic currencies are relatively new, and they differ from other types of Stablecoins in that collateral does not back them.
There are various types of Stablecoin to ensure inclusivity for all types of users, making cryptocurrency accessible to everyone.
Fiat Backup
The majority of Stablecoin users utilize this form of backup. It consists of crypto assets directly backed up by mainstream currencies such as dollars, euros, or even commodities such as gold with a fixed ratio of 1:1. The value of the coin is based on the value of the backup currency instead of fluctuating in value on its own.
In this scenario, a central issuer or bank retains a specific quantity of fiat currency in reserve and issues an equal number of tokens. The most important criterion is that the backing currency’s amount reflects Stablecoin’s circulating supply. For example, if the issuer has $100,000, 100,000 tokens worth $1 each will be created, which can be freely transferred between users.
Stablecoins and Exchange
Stablecoin allows you to avoid the complex financial regulations that come with institutions of fiat currencies. Cryptocurrency regulations are very different from our mainstream banking systems.
Stablecoin Trading
When you are trading cryptocurrency, there is a risk of losing your investments because of the generally volatile nature of the cryptocurrencies’ value.
Stablecoin has a way around this; Stablecoin users can move into a Stablecoin like USD Coin or Tether to immediately lock in their profits. They can also benefit from the arbitrage opportunities when the same currency has a different cost on two other exchanges.
Cryptocurrencies are undoubtedly here to stay, and Stablecoins appear to be the answer to decreasing friction, boosting stability, and, ultimately, enabling the future of money in the digital world.
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