A Simple Introduction to Stable Coins

What are Stable Coins?

  • Class of cryptocurrencies that attempt to offer price stability and are backed by a reserve asset
  • Stablecoins may be pegged to a currency like the U.S. dollar or to a commodity’s price such as gold
  • Stablecoins achieve their price stability via collateralization (backing) or through algorithmic mechanisms of buying and selling the reference asset or its derivatives

How Do Stable Coins Prices Remain Stable?

  • Fiat-Collaterial: stable coins maintain a fiat currency reserve, like the U.S. dollar, as collateral to issue a suitable number of crypto coins
  • Crypto-Collaterial: stable coins are backed by other cryptocurrencies. Since the reserve cryptocurrency may also be prone to high volatility, such stable coins are “over-collateralized”—that is, a larger number of cryptocurrency tokens is maintained as reserve for issuing a lower number of stable coins. For example, $2,000 worth of ether may be held as reserves for issuing $1,000 worth of crypto-backed stable coins
  • Precious Metal Backed: Use gold and other precious metals to help maintain their value. These stable coins are centralized, which parts of the crypto community may see as a drawback, but it also protects them from crypto volatility. Gold has long been seen as a hedge against stock market volatility and inflation, making it an attractive addition to portfolios in fluctuating markets.
  • Non-Collaterialized (Algorithmic): An example could be an increase or decrease the supply of tokens on need basis to keep the stable coin pegged to another currency. Such actions are similar to a central bank printing banknotes to maintain valuations of the fiat currency.

Why are Stable Coins Important?

  • Alternative to fiat money. Rather than using USD and relying on the traditional finance system to make day to day transactions, stable coins enable businesses to accept cryptocurrency without the risk of price volatility
  • Keeps the advantages of the blockchain where its fast, cheap, and secure to transmit

Stable Coin Risks

  • Are only as stable as their underlying asset – and both currencies and precious metals can fluctuate in value
  • Crypto-collateral backed stable coins might be the riskiest since it’s using a speculative asset as a backing. Though it’s “over-collateralized”, a future crypto crash would increase the volatility of the stable coin
  • Regulation is the other risk. Governments are researching the potential impacts to stable coin and whether it would destabilize the global economy. China has completed banned crypto and it is not unlikely that other countries would ban it partially or entirely.

Most Popular Stable Coins by Market Cap

Stable coin is a type of DeFi (Decentralize Finance). To learn more about DeFi: A Simple Introduction to DeFi

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Ricky Young

My belief is that financial freedom cannot be obtained by just a 9-to-5, but a combination of smart investing and passive income. This is my journey to achieve financial freedom.

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