Stablecoin 101: What It Is and How It Can Protect Your Money
The value of money shifts in mysterious ways—it can skyrocket one day and plunge the next. This turn in a currency’s value is often determined by how strong or weak an economy is and unfortunately, this uncertainty can put everyone’s wealth at risk.
Often, investors use precious metals, exclusive real estate, and other valuable assets to preserve their wealth. But if you’re looking at doing things a little differently, a stablecoin is another excellent option to protect yourself from potential losses.
What are stablecoins?
A stablecoin is another type of digital token or cryptocurrency that attempts to mimic or peg its market value to another asset or external reference. Its price may be pegged to the price of commodities like gold, oil, gas, and other reserves or the value of government-issued money like dollars, euro, yen, and more.
As a type of cryptocurrency, stablecoins also run their programs and operations through blockchain technology. They also aim to serve the same functions of traditional money and digital assets, which can be used for payment transactions. They fall under the category of payment tokens, used as a unit of account, medium of exchange, and store of value.
Some of the most popular among the list of stablecoins include Tether (USDT), Dai (DAI), USD Coin (USDC), TrueUSD (TUSD), Paxos Standard (PAXOS), and hundreds more.
However, unlike certain fiat currencies that are very susceptible to inflation and other cryptocurrencies like Bitcoin (BTC) and Ethereum (ETH) that are known for being highly volatile assets, stablecoins are designed to maintain its value or achieve price stability. This is achieved in four different ways.
How do stablecoins work?
To bridge the gap between fiat money and cryptocurrency’s price stability, stablecoins peg their values using different mechanisms. Let’s take a look at its four categories.
1. Fiat-collateralized stablecoins
This type of stablecoin is backed by an existing government-issued currency, such as the United States dollar (USD), often with a 1:1 ratio. This means that equivalent fiat money is held in collateral for every digital coin issued to you. One good example is Tether (USDT), where 1 USDT is always valued at 1 USD.
Fiat-backed stablecoins are the most popular and widely used type of stablecoin in the crypto sphere today. However, it’s considered vulnerable to fraud because they are issued by centralized groups and entities with their own rules and protocols. That’s why it’s important to look for an issuer you can trust.
2. Commodity-collateralized stablecoins
These stablecoins are similar to fiat-backed coins, but instead of fiat money, this type uses other kinds of interchangeable assets and goods as collateral. These include precious metals and minerals like gold, silver, diamonds; valuable commodities like oil and natural gas; exclusive real estates, and many more. One good example of this is Venezuela’s oil-backed cryptocurrency called Petromoneda or Petro (PTR).
3. Cryptocurrency-collateralized stablecoins
Here, instead of fiat money, the stablecoin is backed by cryptocurrencies. Since it uses cryptocurrencies as collateral, the entire process runs and operates on the blockchain in a decentralized manner. Often, crypto-collateralized stablecoins are pegged with a 1:2 ratio.
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Because of cryptocurrencies’ highly volatile nature, a larger number of the cryptocurrency will be held in collateral for every stablecoin. This way, the supply of stablecoins won’t be affected by extreme price fluctuations. An example of this is Dai (DAI), which is backed by collateral on the Maker platform.
However, because of the complexity of cryptocurrencies, this isn’t as popular as its fiat-backed counterparts. Also, because of the high amount held as reserves, it’s often referred to as “over-collateralized.”
4. Algorithmic stablecoins
Also referred to as non-collateralized, these stablecoins aren’t backed by either fiat money or cryptocurrency. Instead, they maintain stability through an algorithm or working mechanism. Smart contracts are in charge of managing the supply and demand scheme and guarantee stablecoin’s price stability.
The algorithmic system will generate new coins if the stablecoin is trading too high. Otherwise, the system will buy coins in the market to cut down its circulating supply. Examples of this are Primecoin (XPM) and the now-defunct Basis. This seems to be the most complicated one among the four, but the algorithmic systems are quite similar to central banks’ processes in managing supply.
Why are stablecoins important?
Like thousands of cryptocurrencies available in the market today, stablecoins also aim to provide developed functions of traditional money across the world. Let’s take a look at some of their significant benefits.
1. Price stability
Stablecoins are designed to have a stable value over any time. Because of this, a lot of crypto geeks and investors consider them an ideal safe-haven asset. The value of fiat money and major cryptocurrencies are experiencing dramatic spikes and plunges every single day, which is why stablecoins are an excellent option for people looking for ways to preserve their wealth. They can store their wealth in an asset without seeing any risk of loss due to inflation.
2. Privacy and decentralization
From what we’ve learned earlier, stablecoins are a type of cryptocurrency. This means they share the same powerful technology and systems that run thousands of other cryptos. However, while cryptocurrencies have a decentralized nature, there might still be a need for ties with a fiat currency’s banking system. On the flip side, this can be a good start for those who can’t go full crypto yet!
3. Programmable currency
Stablecoins are programmable and can be designed to fit the users’ needs since they are “fundamentally made up of code.” One common way of implementing this is through rewards or loyalty programs. If a company builds its program on top of its stablecoin, they can design an application where users can easily and quickly check their stablecoin and rewards at once.
Enjoy the best of both worlds
Aside from the benefits mentioned above, stablecoins can also facilitate faster and cheaper payment transactions. Because of its digital nature, powered by blockchain technology, you can send and receive payments in any part of the world with just a few clicks on your phone. You can also track your funds and payment transactions in real-time!
Cryptocurrencies are developing at a rapid pace in different industries today and digital assets like stablecoins can play an essential role in our transition to the digital world. From providing a way to safeguard our money against the drastic effects of market fluctuations to facilitating faster, adaptable, and secure digital payments, stablecoins can help us achieve financial stability and confront the volatility that so many of us are afraid of.
Ready to experience the best of both worlds? Kickstart your journey and buy USDT today!