What is a stablecoin?

Please see Titan’s Legal Page for additional important information. Stablecoins come in a few variations, but most are pegged to the U.S. dollar. Adam Hayes, Ph.D., CFA, is a financial writer with 15+ years Wall Street experience as a derivatives trader.

Economies thrive on certainty and struggle in volatile conditions, such an unstable currency. In fact one of the main of objectives of Central Banks like the Federal Reserve is to maintain price stability. Because of some concern around the underlying value of certain stablecoins and the potential for fraud, it’s important to know exactly what you’re buying and how it works. There are three main categories of stablecoins available to users, all of which peg their units in different ways.

Seigniorage style stablecoins rely on algorithm-generated smart contracts to supply or sell tokens if the price fluctuates from pegged assets. A stablecoin is a digital asset that remains stable in value against a pegged external traditional asset class. Stablecoin reduces price volatility by backing its value against a conventional asset. The backing asset could be a combination of currencies, a single fiat currency, or other valuable assets. Stablecoins aim to create a stable and reliable environment to increase cryptocurrency adoption and negate digital assets’ speculative nature. They offer the best of both worlds — security and decentralization of cryptocurrencies, with fiat currencies’ stability.

Staking carries risks, however, so make sure you read up on the specifics for the coin you intend to use. The value of most cryptocurrencies is largely determined by what the market will bear, and many people who buy them are doing so in hopes that they will increase in value. If you spend a stablecoin that’s linked to the value of a dollar, you’re less likely to look at cryptocurrency prices the next week and see that you’re missing out on a big gain (or huge loss).

  • If you’re curious about cryptocurrency, think about using some “fun money” — those dollars left over after you’ve built your savings and paid for essential expenses.
  • Treasury and the European Central Bank have expressed concern about this potential flaw in the system and fear stablecoins could melt down and harm investors if they fail.
  • A stablecoin is a cryptocurrency that aims to maintain price stability by pegging its monetary value to a given fiat currency, typically on a one-to-one basis.
  • Dai is a stable hedge against popular digital currencies like Bitcoin or Ethereum.

This uncertainty can make both buyers and sellers hesitant to transact in crypto. Dai is a stable hedge against popular digital currencies like Bitcoin or Ethereum. Since Dai is stable, businesses can rely on it to accept and send stable money on the crypto networks. DAI can also be spent in Europe using the Monolith Visa Debit Card.

USDC is traded on Coinbase, Poloniex, Binance, and other major exchanges like Huobi and Serum Dex. The stablecoin can also be used in several decentralized finance protocols. Traders find it useful to hold USDC as a stable asset that avoids market volatility. Tether allows individuals to quickly and efficiently transfer value from one exchange to another without using a volatile cryptocurrency. The fact that a US dollar backs Tether appealed to stock magnates and daily traders.

A stablecoin is a type of cryptocurrency whose value is pegged to an external, generally stable, asset class such as a fiat currency or gold. Crypto-backed
In this case, stablecoins are issued with cryptocurrencies as collateral instead of being backed by fiat currencies. The main idea here is to peg them to a basket of cryptos or a cryptocurrency what is a stablecoin and how it works portfolio. Since everything is done digitally on the blockchain, the system depends on the use of smart contracts to handle the issuance of units, ensure governance and establish trust. In a nutshell, stablecoins are cryptocurrencies that are designed to minimise price volatility relative to a particular “stable” asset or basket of assets.

A cryptocurrency worth $2 million might be held as reserve to issue $1 million in a crypto-backed stablecoin, insuring against a 50% decline in the price of the reserve cryptocurrency. For example, MakerDAO’s Dai (DAI) stablecoin is pegged to the U.S. dollar but backed by Ethereum (ETH) and other cryptocurrencies worth 150% of the DAI stablecoin in circulation. USDC has gained popularity due to its utility in various applications. It also offers a solution for unregulated exchanges that do not provide conversion to fiat currencies and for customers with restricted access to foreign currencies.

Each CACHE is backed by 1g of pure gold held in the vaults stored around the world. Sending CACHE tokens is the equivalent of sending 1g of gold per token since they can be easily redeemed for physical gold at any time. Since each individual’s situation is unique, a qualified professional should always be consulted before making any financial decisions. Investopedia makes no representations or warranties as to the accuracy or timeliness of the information contained herein. Moreover, politicians have increased calls for tighter regulation of stablecoins. For instance, in November 2021, Senator Cynthia Lummis (R-Wyoming) called for regular audits of stablecoin issuers, while others back bank-like regulations for the sector.

what is a stablecoin

Despite the fact that stablecoins may be less volatile than other forms of crypto, they are still using newer technology which may have unknown bugs or vulnerabilities. And there’s always a chance that you could lose the private keys that give you access to your cryptocurrency, either through a hack or user error. Like everything in crypto, the predicted Annual Percentage Yields (APY) can change day-to-day dependent on real-time supply/demand. But because ETH’s price is volatile, you’ll need to overcollateralise.

However, Tether’s reserves have been shrouded in secrecy over the years, leading to allegations that the company does not hold sufficient dollar reserves to back all USDT in circulation. Tether settled a case with the New York Attorney General in 2021, agreeing to release periodic reports on its reserves. “USDC is fully backed by cash and short-dated U.S. Treasuries, and those reserves are held in the custody and management of leading US financial institutions,” Circle says on its website.

what is a stablecoin

Using the previous example, if that person plans on purchasing more Bitcoin once the price has retraced, all they would have to do is convert the stablecoin value back into Bitcoin. Without stablecoins, users would have to deposit money from a bank account before being able to purchase more cryptocurrency. The biggest example in this category is the DAI (DAI) algorithmic stablecoin, which is pegged to the U.S. dollar but is backed by Ethereum and other cryptocurrencies. Collateralized stablecoins maintain a pool of collateral to support the coin’s value. Whenever the holder of a stablecoin wishes to cash out their tokens, an equal amount of the collateralizing assets is taken from the reserves.

Launched in 2014, BitUSD was the first stablecoin issued as a token on the BitShare blockchain. The pioneering stablecoin was the brainchild of two prominent figures in the blockchain industry, Charles Hoskinson and Dan Larimer. The token was backed by the core token of BitShares, BTS, and was collateralized by a range of other cryptos — all locked in a smart contract to act as collateral. Some types of stablecoins can also be used for crypto staking, in which cryptocurrency owners can earn rewards by essentially lending out their holdings to help execute other transactions.

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