What is a stablecoin and how does it work?

Despite their simplicity, stablecoins can be considered to be one of the cryptocurrency industry’s most significant innovations, allowing for the seamless transfer of stable value. While there are a number of different stablecoin designs, the common backbone of any stablecoin protocol is the data that it receives about the asset it is pegged to. Chainlink provides the battle-tested data infrastructure that helps ensure the reliability, security, and transparency of stablecoins and the stability of the larger DeFi ecosystem. There are various economic mechanisms that stablecoins utilize to maintain relative stability by holding their peg. The most common examples of these include the ability to redeem the tokens for fiat money, collateralized debt positions, arbitrage, elastic supply, and more.

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What Are Stablecoins Used for?

There is also a lack of clarity and standards about reporting the composition of those reserves. Khadija Khartit is a strategy, investment, and funding expert, and an educator of fintech and strategic finance in top universities. She has been an investor, entrepreneur, and advisor for more than 25 years. Adam Hayes, Ph.D., CFA, is a financial writer with 15+ years Wall Street experience as a derivatives trader. Besides his extensive derivative trading expertise, Adam is an expert in economics and behavioral finance.

It’s the native cryptocurrency of Paxos, a financial institution regulated by the NYDFS. While centralised stablecoins are generally less volatile than decentralised cryptocurrencies, they do carry their own disadvantages. Companies issuing centralised assets are not immune to attacks, so customers must trust those organisations to maintain high security standards. They require regular inflows of new capital and are more prone to sell-offs when investors lose confidence.

What is Stablecoin?

This is tricky to answer, and those that are stable in times of great market confidence may shatter when the going gets rough. Historically, U.S. dollar stablecoins such as USDC and Dai have proven resilient during market crashes, maintained their pegs, or temporarily deviated by just a few cents. Stablecoins are cryptocurrencies pegged to the price of another asset. Cryptocurrencies can be too volatile to sustain a peg to the U.S. dollar, as the de-peg of UST in May 2022 demonstrated. When LUNA fell 94% in a single day, the price of UST plunged, and not even Terra’s multi-billion-dollar reserves of Bitcoin could save it. A hacker could exploit faults with the smart contracts to steal the cryptocurrency.

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This type of stablecoin is backed by digital currencies, which leads to a high degree of decentralization since all operations are carried out through the blockchain. The idea of creating a virtual currency became widespread in 2008–2009, which coincided with the acute phase of the global economic crisis, which weakened confidence in national and international financial institutions. You can trade and invest in stablecoins on various cryptocurrency exchanges. Firi currently has Dai, and you can trade safely and easily by reading the guide here. If you need a little more information you can read this guide on DAI and how it works.

How Many Stablecoins Are There?

For instance, the stablecoin DAI is pegged to the USD (one DAI equals $1). But you could have to lock up $150 worth of ether to create $100 worth of DAI. Instead of using any reserve or being backed by assets, these kinds of stablecoins use a fully algorithmic approach to adjust the supply of the stablecoin in response to price fluctuations.

What’s more, the immediacy of settlement means they are not subject to fluctuations in currency values from the time of sending to the time of receipt. That gives both parties confidence in the price validity of the transaction. Moreover, speed is a huge plus as cryptocurrency transactions can take minutes versus transferring money overseas which can sometimes take days.

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What is a stablecoin?

Unlike other stablecoins, DAI is decentralized and uses smart contracts and incentives as the mechanism to maintain its peg. Because the backing asset can be volatile, crypto-backed stablecoins are overcollateralized to ensure the stablecoin’s value. For example, a $1 crypto-backed stablecoin may be tied to an underlying crypto asset worth $2, so if the underlying crypto loses value, the stablecoin has a built-in cushion and can remain at $1.

• Screenshots of buying USDT and USDC on MoonPay.Even though the price of a stablecoin remains fixed to another asset, it still remains relative to other assets.
• Various Registered Investment Company (“RIC”) products offered by third-party fund families and investment companies are made available on the platform.
• The USD is the abbreviation for the U.S. dollar, the official currency of the United States of America and the world’s primary reserve currency.
• This algorithmic stablecoin is designed to help investors execute cryptocurrency trades by providing liquidity, or a flow of tokens, to exchanges.
• If you’ve been following along so far, then stablecoins seem like a good bet, right?

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International payments

Instead of selling crypto for cash and using that cash to buy another crypto, a trader might use a stablecoin. Stablecoins, however, allow these users to take advantage of the stability of fiat currencies without ever going off-chain. One of the biggest concerns with stablecoins is their reliance on a central authority. This goes against the very ethos of cryptocurrencies, which are meant to be decentralized and free from third-party control. This is a big concern for regulators who are already keeping a close eye on the stablecoin space.

Today, the total market capitalisation of all the stablecoins in the world has reached more than USD 150 billion. They command more than half of the global crypto trade volume, making them an important asset in the DeFi ecosystem. Stablecoins are cryptocurrencies that have their price pegged to a specific asset – which is most often, but not always, the United States dollar.

How do you buy and sell stablecoins?

UST is an algorithmic stablecoin — but what is a stablecoin, and how does an algorithmic stablecoin work? These are the best stablecoins that you can buy to avoid volatility or try your hand at staking. Stablecoins allow businesses to diversify their balance sheets, ensure steady cash flow and access new markets, both domestically and abroad.

The risk of stablecoins is then tied up in the reserve and its value, rather than the crypto market in general. Stablecoins serve sort of like a bridge between volatile crypto-assets and highly stable real-world assets. They offer users a greater degree of price stability than other cryptocurrencies. The price fluctuations of cryptocurrencies such as Bitcoin or Dogecoin, for example, can make it difficult for merchants to accurately price their items. If there’s a chance the $5 in crypto a customer paid for a cup of coffee today will only be worth $4 tomorrow, that’s a bad deal for the merchant.

Because cryptocurrency fluctuates in price, the security of the relevant stablecoin must be exaggerated to guarantee a stable price despite exchange rate changes. This means that there must be a much larger value in reserve than the current number of stablecoins in circulation. For example, if one wants to issue 100 stablecoins worth $ 1, there must be a reserve of cryptocurrencies worth $ 150.

What are the most popular stablecoins? How many stablecoins are there?

This happened to Wormhole in February 2022, when 120k Wrapped Ethereum was stolen from its smart contracts. Based on the type of assets they’re pegged to, stablecoins can be classified into a number of categories. The main advantage of stablecoins is that their prices, when working properly, maintain parity with the asset they’re pegged to.

Not tied to the value of other assets

To transact on the blockchain, customers need to convert their fiat currencies into a vehicle that can be used in the crypto world. Stablecoins can be bought on cryptocurrency exchanges such as Coinbase, what is a stablecoin and how it works Binance or FTX. Customers register an account with the exchange and undergo KYC and AML checks. They then deposit an amount of fiat currency with the platform, and execute a trade for a stablecoin.