Stablecoin 101: Definition, Collateral, How They Work

what is a stablecoin

To ensure this can happen, stablecoin creators hold onto reserves of other currencies or assets. Other cryptocurrencies may fluctuate in value relative to, say, the U.S. dollar. In contrast, the price of a stablecoin should not change relative to the currency to which it’s pegged. A stablecoin worth $1 aims to maintain the price of $1; nothing more, nothing less. Bitcoin is a type of cryptocurrency that is known for its volatility, meaning its price frequently goes up and down based on market dynamics. Stablecoins, on the other hand, are designed to maintain a stable value relative to a specific asset or a pool of assets.

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It’s hard to find an investor or trader nowadays who hasn’t held a stablecoin at some point. Stablecoins are often held in crypto exchanges so that traders can quickly capitalize on new market opportunities. They’re also very useful to enter and exit positions without having to cash out into fiat. Apart from trading and investing, stablecoins can be used for making payments and international transfers.

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  • Gaining New York state’s stamp of approval went a long way toward helping Paxos enter the crypto space.
  • Algorithmic stablecoins use an algorithm to get as close as possible to their desired peg value and adjust as needed with the market.
  • Commodity-backed stablecoins are cryptocurrencies that use commodities such as gold, real estate or metals as collateral to provide their stability.
  • The graph below shows USDC’s collateral reserves as of August 2022—at $54 billion, the coin’s reserves are slightly greater than its liabilities of $US53.8 billion.
  • For example, in May 2017, Bitcoin reached a price of $2,000 but then skyrocketed to an eye-popping $19,000 by December 2017.

TerraUSD now trades under TerraClassicUSD (USTC) since the Terra blockchain was officially halted and de-pegged from the U.S. dollar on May 9. Tether is issued by a Hong Kong-based company, called Tether Limited. Learn more about Consensus 2024, CoinDesk’s longest-running and most influential event that brings together all sides of crypto, blockchain and Web3. USD Coin openly has a back door to stop payments if coins are used in an illicit manner. Circle, one of the firms behind USDC, confirmed in July 2020 that it froze $100,000 of the stablecoin at the behest of law enforcement.

Why use stablecoins?

what is a stablecoin

The most prominent fiat-collateralized stablecoin is Tether (USDT) though it’s a bit more controversial. At the time of writing, USDT is the third biggest cryptocurrency by market capitalization, behind just Bitcoin and Ethereum. However, Tether has been plagued by doubts due to a lack of transparency around its actual reserve holdings. Traders like stablecoins because the cryptocurrency market fluctuates wildly, with its market capitalization rising and falling by billions of dollars daily. Bitcoin is generally viewed as one of the safest and most stable digital assets, but it can still see significant fluctuations in its value.

TUSD’s reserves are monitored using Chainlink Proof of Reserve so that holders can autonomously verify that their TUSD is backed by USD held in reserves. Stablecoins can be used by traders and investors to hedge their portfolios. Allocating a certain percentage of a portfolio to stablecoins is an effective way to reduce overall risk.

what is a stablecoin

Launched in 2014, USDT is one of the oldest stablecoins in the crypto market. Some other stablecoins that use a decentralized model, like DAI, have grown in popularity in the crypto community. Rather than maintaining their stable value through fiat reserves, users can lock up cryptocurrency as collateral for borrowing DAI on the Maker DAO platform. There are also a growing number of decentralized lending platforms that allow users to deposit DAI or other stablecoins and earn interest. Network consensus, rather than a centralized team, governs DAI (similar to how Bitcoin works), which maintains a value equal to one U.S. dollar.

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what is a stablecoin

In fact, stablecoins are specifically designed to maintain a fixed price. In an industry where coins and tokens can crash overnight, there is a massive demand for currencies that mix blockchain benefits with the ability to track a more stable asset. If you haven’t started using stablecoins while trading or investing, it’s worth learning more about them as well as the benefits and drawbacks they bring. Stablecoins have become a key component of a developing class of products known as DeFi, or decentralized finance, in which transactions can be carried out without a middleman such as a bank or broker. And some stablecoins, such as Tether and USD Coin, are among those with the highest market capitalizations on the cryptocurrency market. Stablecoins are cryptocurrencies whose value is pegged, or tied, to that of another currency, commodity, or financial instrument.

  • Renowned cryptocurrency analyst Willy Woo has hinted at the possibility of a Bitcoin BTC/USD-backed stablecoin from Tether USDT/USD in the future.
  • When covering investment and personal finance stories, we aim to inform our readers rather than recommend specific financial product or asset classes.
  • Using treasury bills or securities as collateral can be seen as a form of centralisation; to the point, stablecoin giants USDT and USDC have received similar criticisms.
  • Instead, it uses automated algorithms to try to create or decrease supply and hold a steady price.
  • These coins let traders and users of DeFi apps interact with a form of fiat currency directly on the blockchain.

Experts say the DAI stablecoin is overcollateralised, meaning the value of cryptocurrency assets held in reserves might be greater than the number of DAI stablecoins issued. Commodity-backed stablecoins are cryptocurrencies that use commodities such as gold, real estate or metals as collateral to provide their stability. Of these, gold is generally the most popular commodity used as collateral for commodity-backed stablecoins.