What Is a Stablecoin — A Full Guide

You’ll come across many terms in the crypto world, from coins and tokens to altcoins and stablecoins. Each of them has its purpose, including stablecoins.

The first stablecoin was launched in 2014, while today, there are about 200 stablecoins, of which Tether (USDT) is the most prominent. If you are interested in learning what stablecoins are and what their use cases are, keep on reading. We’ll also talk about the main types of stablecoins and their advantages and disadvantages.

What Is a Stablecoin?

The stablecoin definition could be laid out in the following way — stablecoins are bridges between digital and traditional currencies. Their goal is to reduce volatility and stabilize the price of cryptocurrencies. This stability is achieved by tying digital currencies to reserve assets, like fiat or gold. For example, if a stablecoin is tied to the US dollar, its value will always be $1.

Stablecoins can also be seen as blockchain versions of traditional currencies. This means they can interact with smart contracts and applications based on blockchain.

BitUSD was the first stablecoin. This token was launched in 2014 and was supported by BTS, a native token of the BitShares blockchain. BitUSD has served as collateral for many other stablecoins, as well as fiat currencies.

Keep in mind that stablecoins are not regulated by the government. This means that they will not always be accepted as legitimate. Moreover, stablecoins can sometimes depeg. This happens when the price of the stablecoin deviates greatly from the value of its fiat counterpart.

Many reasons can trigger the depegging of stablecoins. The most common are market manipulation, lack of collateralization, and faulty design in the stablecoin mechanism.

How Does a Stablecoin Work?

What is the purpose of a stablecoin? Stablecoins aim to maintain their stability by linking their value to the reserves with which they are connected on a 1:1 basis. Stablecoins are most often tied to fiat currencies, like the US dollar. So, if a stablecoin is linked to the US dollar, its value will always be $1.

However, they can also be backed up by other cryptocurrencies, or traditional assets, like gold. Moreover, they can maintain their stability using algorithms that will automatically regulate the amount of stablecoins in circulation.

In addition to that, stablecoins will allow crypto buyers and sellers to withdraw their funds without having to convert them into their country’s national currency.

With that in mind, most stablecoins operate using a reserve system. Since Tether (USDT) is the most popular stablecoin, we’ll use it as an example to show you how stablecoins work.

If you buy $200 in USDT, $200 will be added to the USDT reserve, while 200 USDT will be minted and sent to your crypto wallet. The same goes for selling stablecoins. Namely, if you sell 200 USDT, $200 will be removed from circulation. However, this money will be taken from the USDT reserve.

What Are Stablecoins Used For?

Now that you know what is the point of a stablecoin, let’s find out how to use them. Stablecoins can be used for conducting global payments, trading and investing, and online gaming.

Global Payments 

Many financial institutions use stablecoins to conduct global payments. Unlike fiat, stablecoins provide faster transactions. Moreover, they come with lower fees since they don’t use intermediaries — all transactions are performed on the blockchain. Stablecoins are also more secure and they operate 24 hours per day.

Trading and Investing

Crypto investors often use stablecoins for trading. Why? Because they are less volatile than major cryptocurrencies. Moreover, they can help them diversify their portfolios. On the other hand, long-term investors usually use stablecoins for staking and holding. However, stablecoins can also be used as a means of exchange.

Online Gaming

Stablecoins play an important role in the gaming sector — they give value to in-game currencies and items. In other words, players can exchange their items and coins for stablecoins which they can then convert to fiat. Stablecoins can also be used for online gambling at crypto casinos. 

Stablecoin Types

There are four types of stablecoins:

• Fiat-collateralized stablecoins
• Crypto-collateralized stablecoins
• Commodity-collateralized stablecoins
• Algorithmic stablecoins

The first two types of stablecoins use fiat and crypto assets as collaterals, while commodity-collateralized stablecoins are backed by precious metals, such as gold and silver. On the other hand, algorithmic stablecoins use algorithms to determine the price.

Fiat-Collateralized Stablecoins

As their name indicates, these stablecoins use fiat as collateral, usually the US dollar. These collaterals are not locked into smart contracts, as they exist outside the blockchain. The most popular fiat-collateralised stablecoins are Tether (USDT), USD Coin (USDC), and Binance USD (BUSD).

Crypto-Collateralized Stablecoins

These types of stablecoins use cryptocurrencies as collateral instead of fiat. They also play a major role in the DeFi ecosystem. Namely, these stablecoins are obtained by locking crypto assets within a smart contract. The most prominent crypto-collateralized stablecoins are MakerDAO (DAI) and EOSDT Token.

Commodity-Collateralized Stablecoins

Commodity-collateralized stablecoins use precious metals, such as gold and silver as their collateral. Examples of commodity-collateralized stablecoins include Digix (DGX) and PAX Gold (PAXG).

Algorithmic Stablecoins

These types of stablecoins use algorithms to determine the price and the number of tokens in circulation. These algorithms prevent price spikes by releasing additional tokens into circulation. The most recognized algorithmic stablecoins are DefiDollar (DUSD) and Ampleforth (AMPL).

Benefits of Stablecoins

The main benefits of stablecoins include:

• Volatility regulation
• Enabling fast and low-cost transactions
• Enabling micropayments
• Safer storage options
• Providing access to financial services 24/7

Stablecoins Risks

The main risks of using stablecoins include:

• Depegging, i.e., deviations from the pegged value
• Regulatory issues
• Inflation of pegged assets

Examples of Stablecoins

The most popular stablecoins are:

• Tether (USDT)
• USD Coin (USDC)
• Binance USD (BUSD)
• Dai (DAI)
• EOSDT Token
• Digix (DGX)
• PAX Gold (PAXG)
• TrueUSD (TUSD)
• DefiDollar (DUSD)
• Ampleforth (AMPL)

Conclusion

The easiest way to get the stablecoins explained is to represent them as a bridge between traditional currencies and blockchain technology. Their goal is to protect the cryptocurrency market from volatility and to enable fast and cheap transactions.

There are four types of stablecoins. Each type uses a different collateral. The only exceptions are algorithmic stablecoins that don’t use collaterals but algorithms. The biggest disadvantage of stablecoins is related to depegging, regulatory problems, and inflation of the pegged assets.

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