What Are Stablecoins? Definition, How They Work, Types

As the name implies, stablecoins aim to address this problem by promising to hold the value of the cryptocurrency steady in a variety of ways. Some people in the UK use stablecoins which are linked to the US dollar or other currencies. At the moment a small number of stablecoins are linked to the UK pound. Finally, another company provides a digital wallet which can be used on a smartphone or other pieces of hardware and software. The owner of the stablecoins can use this wallet to essentially store, send and receive their coins.

In many cases, these allow users to take out a loan against a smart contract via locking up collateral, making it more worthwhile to pay off their debt should the stablecoin ever decrease in value. In addition, to prevent sudden crashes, a user who takes out a loan may be gambling with digital and virtual currencies liquidated by the smart contract should their collateral decrease too close to the value of their withdrawal. Despite the differences in stablecoin architecture, design, and risk, all stablecoins require accurate price data for their underlying pegging mechanism and when used in decentralized applications. Since exchange rates are constantly fluctuating, real-time price data needs to be fed to stablecoins in order for them to maintain their peg. Furthermore, since stablecoins are usually backed by other crypto assets or off-chain bank reserves, tamper-proof methods of acquiring the details of these reserves are needed to ensure the security and reliability of these systems. The technical implementation of this type of stablecoins is more complex and varied than that of the fiat-collateralized kind, which introduces a greater risk of exploits due to bugs in the smart contract code.

Definition: What are stablecoins?

Fiat-backed stablecoins are described as an IOU — you use your dollars (or other fiat currency) to buy stablecoins that you can redeem later for your original currency. Unlike other cryptos, with value that can fluctuate wildly, fiat-backed stablecoins aim to have very small price fluctuations. But that’s not to say stablecoins are a totally safe bet — they are still relatively new with a limited track record and unknown risks, and should be invested in with caution. The cryptocurrency exchange Coinbase offers a fiat-backed stablecoin called USD coin, which can be exchanged on a 1-to-1 ratio for one U.S. dollar. Commodity-backed stablecoins are cryptocurrencies that use commodities such as gold, real estate or metals as collateral to provide their stability.

Yet because they hew to the value of a single fiat currency, they act as a sort of temporary refuge for investors looking to secure their funds during a bear market. In this way, stablecoins are like blockchain-enabled versions parkour long sleeve t shirt baseball urban dash evolution free running runner of the dollar. These differ considerably in their form and usability but are all backed by investment-grade gold. Stablecoins were invented to fill this need and provide an important addition to the cryptocurrency marketplace. Stablecoins were created to provide stability, long-term purchasing power and the predictability of a fiat currency alongside the utility benefits of cryptocurrencies.

Then the stablecoin is issued to the broader public through another type of infrastructure known as a ledger. With cryptoassets, like Bitcoin, their value tends to move up and down a lot in a short space of time. It is one reason why cryptoassets like Bitcoin are not widely used to pay for things. An example of a cross-border payment is when someone sends money to family or friends in another country. But, because stablecoins have a stable value, people may start using them more to pay for a wider range of things. A stablecoin is a form of digital asset that can be used to make payments.

For many, this is kyber network exchange review the drawback of the centralized model—the fact investors holding such stablecoins are taking on counterparty risk. Cryptocurrencies worth $2 million might be held as a 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 pegged to the U.S. dollar but is backed by Ethereum (ETH) and other cryptocurrencies worth about 155% of the DAI stablecoin in circulation. Stablecoins are crypto assets that aim to keep their price “pegged” to the market value of an external asset such as fiat currency or commodity.

Coin Prices

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. Typical examples include selling governance tokens that allow buyers to gain voting control over the stablecoin’s future or locking up funds into smart contracts on the blockchain to earn interest. Stablecoins allow investors to move in and out of different cryptocurrencies while staying within the cryptocurrency realm. At a market cap of $66.9 billion, USDT is currently the third biggest cryptocurrency, behind Bitcoin and Ethereum (ETH).

1. Our estimates are based on past market performance, and past performance is not a guarantee of future performance.
2. Our proposed rules are to regulate stablecoins that would become widely used for payments in the UK.
3. If you’re a developer and want to integrate Chainlink into your smart contract applications, check out the developer documentation or reach out to an expert.
4. Gold has long been seen as a hedge against stock market volatility and inflation, making it an attractive addition to portfolios in fluctuating markets.
5. They also maintain reserve assets as collateral or through algorithmic formulas that are supposed to control supply.
6. The desire for stable assets on blockchains has resulted in the wide adoption of stablecoins within the blockchain industry and decentralized finance (DeFi).

These specific Stablecoins allow holders to participate in the gold market and have the utility benefits of a cryptocurrency without the challenges of physically owning gold bars. TerraUSD (UST) was the biggest algorithmic stablecoin, reaching a market cap of more than $18.7 billion at its peak on May 5 before it began to plummet sharply after it slipped below its peg. Recent events have taught us that not all stablecoins are created equal. In May 2022, the meltdown of TerraUSD showed that not every stablecoin can guarantee price stability. You can invest in stablecoins like Tether on some of the best crypto exchanges and apps like Kraken and Coinbase.

Money, payments and spending

However, in practice, few, if any, stablecoins meet these assumptions. On the other hand, decentralized stablecoins have revenue modes that vary from protocol to protocol. TerraUSD’s price was pegged at $1 via the minting (creation) and burning (destruction) of a sister coin, Luna. There was no collateralization, with the entire model running via this algorithmic minting and burning of Luna tokens each time a UST stablecoin was bought or sold. USDC is a stablecoin outlier in disclosing precise data regarding its assets and liabilities. There has long been controversy about the reliability of the collateralizing reserves regarding certain stablecoins (i.e., that the stablecoin’s liabilities are higher than its reserves).

Collateralized Stablecoins

Stablecoins are a key innovation that pioneered a now increasingly important subset of the Web3 ecosystem known as tokenized real-world assets (RWAs)—or the tokenization of assets that society today uses on a daily basis. They are an early indicator of the benefits and efficiencies that mass adoption of digital assets can bring. The regulation aims to make sure stablecoins always maintain a stable value, so people who hold them can get their money back. We also want to make sure people can pay using stablecoins without disruption. And we want to make sure stablecoin wallets are safe to use and respect people’s legal rights.