Cryptocurrency carries this cryptic veil around it. Its coins allure investors new and veteran, far and wide, hoping to strike digital gold by gambling with its infamous volatility. Stablecoins, however, suffer from a keen lack of volatility.
Likely you know about Bitcoin, Ether, and the sporadic rollercoaster affecting their prices. Less likely you know about the intrinsic details and uses of fiat-backed stablecoins, and why regulators of the traditional banking world appear to like them.
This article walks you through stablecoins, from their basic mechanics to their incredible uses as digital coins pegged to respective fiat currencies.
Stablecoin is an umbrella term referring to any cryptocurrency (crypto) whose value is pegged to the value of an external asset, often a fiat currency.
Popular crypto, such as Bitcoin, provide the essential benefit of removing all intermediaries in your daily use of cash. This opens up “banking” to any one person living on the globe. Yet a key weakness is the volatility inherent to most crypto coins as our world adjusts to this new asset class.
Enter stablecoins, whose aim is to remain, well, stable. How a stablecoin achieves this depends on the coin.
We have four common types: fiat-backed, commodity-backed, crypto-backed, and algorithmic. Each type maintains a reserve of an external asset “backing up” the stablecoin’s value. Algorithmic refers to an unbacked or partially-backed coin primarily using algorithms to manipulate supply and demand to maintain the often 1:1 peg against the external asset.
The base mechanic of a fiat-backed stablecoin feels almost too simple. When a user wishes to exchange their tokens, they simply return them as they receive the fiat equivalent from the coin’s reserve. The exact dollar-to-coin count is maintained, and the peg, unaffected.
Yet fiat-backed stablecoins possess certain nuances which must be addressed.
First, any fiat-backed stablecoin derives its value from the value of its reserves. Whether these are in euros or in US dollars, both the regulators and investors must feel confident in the coin’s ability to maintain its (likely) 1:1 peg.
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