Stablecoin 101: Definition, Collateral, How They Work


The code controls the execution of the agreement, and transactions are trackable and irreversible. As of late July 2023, Tether (USDT) was the third-largest cryptocurrency by market capitalization, worth more than $83 billion. Stablecoins may be better used as a form of digital cash rather than a speculative investment. Given high levels of distrust in cryptocurrencies, investors tend to resort to safer options like Stablecoins. This volatility is both a driver and result of the lack of public (whether institutional or individual) trust in cryptocurrency as a reliable and balanced currency option. Poor and undefined regulation also play a role  in adding to this distrust.

“Users will be able to send and receive the currency of their choice over the Lightning Network, using the existing bitcoin liquidity as a global routing currency and Medium of Exchange,” explained Gentry. Formerly known as “Taro,” Taproot Assets leverages Bitcoin’s “Taproot” upgrade from 2021, which bolstered the network’s smart contract capabilities while improving the privacy and memory efficiency of transactions. Even before the pandemic, paying with digital cash was becoming more and more attractive.

The stablecoin has managed to gain a reputation for transparency through regular audits, fully backed collateral, and fulfilled legal requirements for the USD-peg. In the same way that a fiat-collateralized stablecoin has fiat tender as collateral, a crypto-collateralized stablecoin has cryptocurrency locked up as collateral, such as Ethereum. Indeed, the Biden administration recently said that stablecoins could change how we pay for everything. As buying digitally becomes ever more embedded in our lives, stablecoins offer an affordable, stable, and easily accessible way for consumers and businesses to move value globally, today and in the future. The main question is whether stablecoin operators hold sufficient cash reserves to meet their promise of a one-to-one exchange of value with the dollar. For example, if everyone started taking their coins out at once, it could have devastating effects.

The result is an entirely new subset of the cryptocurrency market known as stablecoins. These tokens are meant to function the way their name suggests — with stability. Simply put, a stablecoin in cryptocurrency is a token which has its value pegged to the price of a national currency in order to combat its volatility. There are several types of stablecoins and numerous options and different projects which offer the same fundamental idea of a cryptocurrency coin which has more stability than Bitcoin or altcoins. Using this method, efficient, highly liquid algorithmic stablecoins often maintain their value to within about 0.002% of the peg.

He is a CFA charterholder as well as holding FINRA Series 7, 55 & 63 licenses. He currently researches and teaches economic sociology and the social studies of finance at the Hebrew University in Jerusalem. For now, the current Taro release supports on-chain functionality, though it will later be compatible with the lightning network. Lightning enables instant and virtually free BTC transfers by processing transactions in private payment channels off-chain, before settling transactions on-chain.

How Do Stablecoins Work

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. 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. In this case, stablecoins could be the next step towards widespread adoption, which is ultimately beneficial for the cryptocurrency industry. Similarly, Evertas seeks to catalyze mass adoption in the Web3 ecosystem by reducing the uncertainty confronting crypto custodians, such as exchanges.

  • Although the ability to redeem gold-backed stablecoins for physical gold is universal across active platforms, other commodity-backed stablecoins lack the same utility.
  • Crypto-backed stablecoins are cryptocurrencies that use one or more cryptocurrencies as collateral to provide their stability.
  • Stablecoins were created to provide stability, long-term purchasing power and the predictability of a fiat currency alongside the utility benefits of cryptocurrencies.
  • With them, you can go on the rides, try your luck at the ring toss, and buy cotton candy and popcorn.

Fiat-collateralized stablecoins are designed to be fully backed by reserves of government-issued currencies and short-duration investment grade sovereign debt securities. Because the assets held in reserve are either the stablecoin’s reference asset or a highly liquid equivalent, fiat-collateralized stablecoins can be directly exchanged for their fiat pair, and vice versa. To mint new units of a stablecoin, users can deposit USD to a stablecoin issuer who will mint a corresponding amount of stablecoins.

How Do Stablecoins Work

Decentralized stablecoins, for example, are more transparent and also more stable than conventional stablecoins because their value is automatically stabilized. As decentralized stablecoins become larger, they can provide more stability and transparency within the traditional financial system. Over time, inflation can erode the purchasing power of the underlying asset to which a stablecoin is pegged. First, you might want to keep money in the cryptocurrency system, but you don’t think it makes sense to invest in bitcoin (or a different cryptocurrency) right now. It’s a bit like keeping cash in a brokerage account while waiting to make an investment. However, stablecoins are still susceptible to de-pegging or peg failures.

These benefits make stablecoins more competitive than other cryptocurrencies, as they relieve a number of consumer and business pain points. BTC and other cryptocurrencies are currently not able to offer the same level of stability and scalability for real-time transactions as compared to stablecoins. 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.

Centralized stablecoins provide a digital option with the backing of a traditional currency. Stablecoins are crypto tokens typically pegged to a fiat currency, like USD or EUR, so they can usually be exchanged one-to-one for the non-cryptocurrency in question. As swings in crypto prices occur, this feature allows businesses and consumers to use crypto for regular payments, allowing the value of goods exchanged to remain stable even as crypto prices fluctuate. At the same time, payments using stablecoins are still fast, transparent, and secured on the blockchain. Stablecoins offer several advantages, such as price stability, fast and low-cost transactions, and increased accessibility to financial services. They can provide a reliable medium of exchange and store of value, especially in regions with volatile local currencies or limited access to traditional banking services.

The value of stablecoins of this type is based on the value of the backing currency, which is held by a third-party–regulated financial entity. Fiat-backed stablecoins can be traded on exchanges and are redeemable from the issuer. The stability of the stablecoin is equivalent to the cost of maintaining the backing reserve and the cost of legal compliance, licenses, auditors, and the business infrastructure required by the regulator. Stablecoins have been incredibly popular as they provide the perfect balance of the benefits offered by decentralization with the added value of predictability. Although some decentralized versions have struggled to maintain their given price point, which has caused a lot of uncertainty about the concept, it seems that all confidence for stablecoins has not been lost. As with other cryptocurrencies, countries continue to look for ways to regulate stablecoins and increase transparency.

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. If you’re looking to add some riskier assets to your portfolio, individual stocks can also fill that role. 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.

However, it is important to remember that these commodities can, and are more likely to, fluctuate in price and therefore have the potential to lose value. Seigniorage is the difference between the value of money and the cost of printing it. NNon-collateralized stablecoins rely on a mechanical algorithm what is a stablecoin and how it works which changes the supply volume as needs be in order to maintain their price. With over 42.8 billion coins in circulation, USD coin (USDC) is an example of a stablecoin. These cryptocurrencies, called stablecoins, aim to minimize price fluctuations and provide stability in their value.