Financial Education

What Are Stablecoins?

June 22, 2021

If you’re looking for a way to get started in the world of crypto but don’t know where to start, stablecoins may be worth looking into!

So what are stablecoins exactly?

Essentially, stablecoins aim to offer price stability and make it easy to make a transaction - just like using traditional fiat currencies. Most stablecoins attempt to target a specific value, using smart contracts to strike a balance between supply and demand. 

This creates price stability. 

Stablecoins get their name in that they are “stable,” or backed up by collateral assets (both cryptocurrencies and traditional fiat currencies), and they become tied or pegged to a specific value. For example, USDC (a common stablecoin) is backed by the US dollar.

By starting an investment with stablecoins, you can avoid the large swings in price associated with cryptocurrencies like Ethereum and Bitcoin. This type of cryptocurrency maintains its value over time and gives both investors, and those just getting started, value-stable assets they can put to work. 

So far, it may seem as though stablecoins are contradicting the original intent behind the creation of traditional cryptocurrencies. However, they are a great option to consider when looking to make moves in the market as you can avoid fiat currencies completely and use stablecoins to liquidate your positions seamlessly on most crypto wallet platforms!

Let’s take a look at three different examples of stablecoins, USD Coin, Tether, and DAI.

Most stablecoins use dollar reserves to back up their valuation, issuing out an equal amount of tokens. These reserves are routinely audited to ensure the protocols are secure, furthering the case for stablecoins’ accessibility when making everyday purchases.

One of the most well known stablecoins, USD Coin, was created by Circle and is governed by members of Centre, a Coinbase group. Circle states that USDC is fully backed by fiat reserves with about 23 billion in circulation. This stablecoin runs on the Ethereum, Stellar, Algorand, and Solano blockchains making stablecoins accessible across a number of blockchain solutions.

Tether is another popular stablecoin, backed by traditional currencies like the US Dollar, the Euro, and the Japanese Yen. As it exists today, Tether (USDT) has the largest market capitalization and circulation out of all stablecoin protocols, dominating over half of all stablecoin transactions. Focusing on economic conditions, the Tether stablecoin is used to bring together cryptocurrencies and fiat currencies, offering a value stable asset through somewhat traditional means. Tether’s asset reserves are centralized in that they are stored in a bank, but remain undisclosed. At the time of writing, Tether’s market capitalization was valued at over $43 Billion.

All stablecoins are able to achieve price stability through the collateral that backs them up. While Tether gauges economic factors to help make this happen, others like DAI use a smart contract platform connected to feedback mechanisms to facilitate their protocol.

DAI was created by MakerDAO, an Ethereum based protocol enabling anyone to deposit their cryptocurrency to take out a loan in DAI. This concept is known as a Collateralized Debt Position (CDP). If a user has a CDP, they’ve deposited an asset into Maker’s smart contract as collateral in order to receive a loan in DAI. 

Maker or MKR is connected to the DAI token and fluctuates its total supply to stabilize the value of DAI, targeting $1 USD. When the price of DAI stabilizes, MKR is removed from circulation or “burned.” On the other hand, when DAI’s valuation is in flux, MKR is put into circulation and increases the supply. 

A stablecoins’ purpose is in its name - to remain stable and make it a viable asset that businesses and individuals can easily use. Unlike cryptocurrencies that experience erratic periods of volatility, stablecoins remain a fixture in the open finance space and are relied upon by numerous investors. In a sense, they offer the advantages of value stable traditional currency and the efficiency of cryptocurrency transactions. Their reliability shines amongst the volatility we see in new and existing cryptocurrency tokens!

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