A stablecoin is a type of cryptocurrency specifically designed to maintain a stable market price. Recently, there has been a surge in the popularity of these digital currencies, leading to the emergence of numerous stablecoin projects.
While the precise mechanisms may differ across various coins, stablecoins are intended to be resilient against market volatility, aiming to avoid significant price fluctuations.
Many stablecoins derive their value by pegging it to the price of another asset. While most are linked to the US dollar, there are stablecoins pegged to the value of other cryptocurrencies, as well as commodities such as silver or gold. By being pegged to real-world assets, these coins circumvent the extreme price swings commonly observed in cryptocurrency markets.
Collateralized stablecoin companies are expected to hold the actual assets to which their coin is pegged, such as the US dollar or gold. They issue new units based on the value of their holdings. This model underpins the majority of stablecoins. Well-known examples include USD Coin (USDC), Paxos (PAX), and TrueUSD (TUSD), where each token is backed on a 1:1 ratio by funds held in bank accounts. These companies only issue new stablecoin units when they receive an equivalent value in fiat currency.
Some stablecoins are pegged to other cryptocurrencies rather than fiat or commodities, commonly known as crypto-collateralized stablecoins. The peg of these coins is maintained through over-collateralization and stability mechanisms. An exemplar is DAI, the stablecoin minted in the Maker DAO ecosystem.
On the contrary, non-collateralized stablecoins utilize algorithms to manage the token supply, aiming to sustain a fixed price level. The objective of these coins is to maintain a stable value by algorithmically adjusting the circulating supply in response to market behavior.
Stablecoins aim to combine the advantages of both fiat currency and cryptocurrency worlds. Currently, stablecoins are primarily utilized as a hedge against the high volatility of cryptocurrency markets. However, depending on the context, they can also serve as a stable currency offering enhanced transparency and decentralization. Compared to traditional fiat currencies, stablecoins enable faster transactions and lower fees, making them valuable for everyday payments and international transfers.