Stablecoins are digital assets that are pegged to another asset with a fairly consistent value. They are designed to maintain this consistent value relationship, unlike other cryptocurrencies which can greatly fluctuate in value. I want to provide a basic understanding of stablecoins and their potential applications. First, how do stablecoins differ from other cryptocurrencies. What are the different types of stablecoins and their potential applications.
Stablecoins are a type of digital asset that is designed to maintain a stable value. They are typically pegged to a fiat currency such as the US dollar or a basket of currencies. The most common type of stablecoin is a fiat-collateralized stablecoin. This type of stablecoin is backed by a reserve of fiat currency and is designed to maintain a 1:1 ratio with the underlying asset. A popular example is Tether or USDt which is pegged to the value of the US dollar.
Types of Stablecoins
- Fiat Collateralized stablecoin
The most common type of stablecoin is currently the fiat-collateralized stablecoin, which is backed by a reserve of fiat currency. This type of stablecoin can be considered to be the most reliable, as it is meant to be backed by a stable asset. However, an independent regular audits must be provided before this can be accepted as accurate.
- Crypto-collateralized stablecoin
This type of stablecoin is backed by a reserve of cryptocurrency. It is designed to maintain a value that is a multiple of the underlying asset.
Other types of stablecoins include algorithmic stablecoins and non-Stablecoins are a type of cryptocurrency that maintain a relatively stable price. They are not tied to any particular asset, but rather are designed to remain as close to a certain value as possible. This type of cryptocurrency has become increasingly popular in recent years due to its promise of stability and its potential use in everyday transactions.
- Non-collateralized stablecoin
This type of stablecoin is not backed by a reserve of any asset, but rather is designed to maintain its value through algorithms. The algorithms are designed to respond to market fluctuations and adjust the supply of the stablecoin accordingly, in order to maintain its value. This type of stablecoin was considered attractive because it is not tied to any particular asset, and is also relatively easy to implement. However, this type of stablecoin is also vulnerable to market fluctuations, as the algorithms may not always be able to accurately respond to the market. In 2022 TerraUSD (UST) and its sister coin luna failed due to unanticipated market volatility and an overall downward trend causing the balancing act for this particular stablecoin to fail. The reflexivity of the system meant that when demand for UST falls, sell pressure on luna increased. This resulted in a downward spiral that saw the price for both plunge to near zero.
- Central bank digital currency (CBDC)
This type of stablecoin is issued by a central bank and is backed by the central bank’s reserves. The value of the stablecoin is pegged to the value of the central bank’s reserves, and the reserves are used to ensure that the stablecoin maintains its value. This type of stablecoin is attractive because it is backed by a trusted asset, and is also relatively easy to implement. However, this type of stablecoin is also vulnerable to market fluctuations, as the value of the central bank’s reserves can change rapidly. Most of the world’s governments are developing or considering the development of a CBDC.
Many people believe that when CBDCs are fully developed other stablecoins will be considered redundant.