Stablecoin is a type of cryptocurrency whose value is tied to an outside asset, such as the U.S. dollar or gold, to stabilize the price.

What is a stablecoin?

Stablecoins are cryptocurrencies that claim to be backed by fiat currencies—dollars, pounds, rubles, etc. The idea is that, unlike cryptocurrencies like Bitcoin, stablecoins’ prices remain steady, in accordance with whichever fiat currency backs them.
Stablecoins are used as stores of value or units of account, as well as in other use cases where volatile cryptocurrencies may be less desirable. Different stablecoins use different strategies to achieve price stability; some are centralized, others are decentralized.

What are some examples of stablecoins?

Centralized Stablecoins

💵 Tether (USDT): Tether is one of the first stablecoins and the most famous. It claims it is backed by a reserve of real dollars—”collateral”—that is “off-chain,” i.e. in a real-world location that is controlled by a centralized third party. With this stash safely in the vault of a bank, investors can be confident that their tethers really are worth one dollar each, keeping the price steady. The stablecoin accounts for a whopping 48% of all cryptocurrency trading volume. There’s only one problem: Tether Ltd, which mints Tether tokens, has never conclusively proven that the currency really is fully backed.

💰 Gemini Dollar (GUSD)/Paxos Dollar (PAX)/USDC: Developed by venture capitalists the Winklevoss twins, blockchain startup Paxos, and crypto exchange Coinbase (in concert with payment platform Circle) respectively, these stablecoins are currying favor with the institutional investors—all have been closely audited by Wall Street firms and are compliant with local regulatory regimes. As Tether becomes less trusted, these tokens only become more popular.

Gold-backed stablecoins

While the vast majority of stablecoins are backed by US dollars stored in a bank vault, weakening sentiment around the USD and the fiat, in general, has led to the elaboration of stablecoins backed by other assets, including various gold-backed cryptocurrencies. These differ considerably in their form and usability but are all backed by investment-grade gold.

ACHE gold (CACHE) is among the most popular of these. 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.

There’s also Tether Gold (XAUt) and PAX Gold (PAXG), which operate in a similar way, but are instead pegged to one troy ounce of investment-grade gold. They also have a higher minimum redemption amount than CACHE.

Algorithmic stablecoins

  • Terra (LUNA) is a decentralized stablecoin, which means rather than relying on a trusted third party it uses a complex algorithm to keep stable. To do this, it balances “on-chain” reserves—i.e. the funds are held in smart contracts—with supply and demand automatically, mitigating the chances of traders accidentally—or intentionally—fiddling the price.
  • Ampleforth (AMPL) relies on a similar process. Instead of physically backing each AMPL with 1 USD, it instead uses a process known as a “rebase” to automatically adjust the circulating supply of the cryptocurrency in response to changes in supply and demand. If the price of AMPL is more than 5% above or below the USD reference price, then it will increase or decrease the circulating supply in an effort to push the price back towards $1. Since this rebase is proportional across all wallets, AMPL holders always maintain their share of the overall AMPL network.
  • Dai (DAI) is said to stand out from other competing stablecoins because it can be widely used while staying decentralized and trustless. DAI, which was created by blockchain company MakerDAO, is an ERC20 token whose value is pegged to the US dollar, and can be used for transfers between Ethereum wallets.

How are stablecoins used?

Like other digital assets, stablecoins are primarily used as a store of value and as a medium of exchange. They give traders temporary reprieve from volatility when the market is tumbling, and can also be used in the rapidly growing world of decentralized finance (DeFi) for things like yield-farming, lending, and liquidity provision.

Most traders and investors gain exposure to stablecoins by purchasing them from exchange platforms, but it is also often possible to mint fresh stablecoins by depositing the requisite collateral with the issuing company, such as US dollars with Tether or physical gold with CACHE gold.

Reference: Decrypt

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