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The 4 Types of Stablecoins, Explained
Kevin Callahan
Cryptocurrencies have become increasingly popular in recent years, but their volatile nature can make them difficult to use as a form of payment. Stablecoins are a novel solution designed to minimize this price volatility and ensure price stability over time.
The stablecoin market exploded in 2020-21, growing by almost three times. So, what precisely is so great about this asset? What types of stablecoins are out there? And, perhaps most importantly, how do they even work?
What are stablecoins?
Like most of our 'traditional' currencies (USD, EUR, etc.), stablecoins are alsobacked by some asset. In the finance world, it's called collateral. Although this collateral structure can vary, stablecoins always have the same objective: stability.
Popular stablecoins include Tether (USDT), USD Coin (USDC), Binance USD(BUSD), and many others.
You can see that USDT is stable over time because it's directly tied to USD value:
4 Types of Stablecoins
The value of a stablecoin is usually linked to the underlying asset, so it remains relatively stable over time. There are four common types of stablecoins, each with its own strengths and weaknesses.
Fiat-backed
The first type of stablecoin is backed by fiat currency. These coins are pegged to the value of a national currency, such as the US dollar, and can be redeemed for an equivalent amount of the fiat currency. Fiat-backed stablecoins offer the stability of traditional currencies, but they are subject to the same economic conditions. For example, if the US dollar value decreases, the value of the stablecoin will also decrease.
Commodity-backed
The second type of stablecoin is backed by physical assets like precious metals, oil, and real estate. These assets provide a more stable foundation than fiat currencies but can be difficult to redeem. For example, if you want to redeem a gold-backed stablecoin for US dollars, you would need to find a buyer who is willing to accept the coin at its current value.
Crypto-backed
The third type of stablecoin is backed by cryptocurrencies. These coins are often referred to as “crypto-collateralized” stablecoins. They are backed by a pool of cryptocurrencies, which helps to stabilize their value. However, if the price of the underlying cryptocurrencies fluctuates, the value of the stablecoin will also change.
Algorithmic
The fourth type of stablecoins is not backed by any asset. These “uncollateralized” stablecoins are instead supported by algorithms that attempt to maintain their stability.
For example, when the market price falls below the price of the fiat currency it tracks, an algorithmic stablecoin system will reduce the number of tokens in circulation.
However, they are not as widely used as other types of stablecoins, and their long-term viability is still uncertain.
Real-life use Cases of Stablecoins
Nowadays, there are several ways to use stablecoins in real-life. For example, they can be used to send money overseas without incurring costly transaction fees.
As the use of stablecoins grows, more businesses and individuals will likely start accepting them as a form of payment. They can also be used to purchase goods and services online or even to send payments to your friends or family. Think of it as a PayPal or Venmo of the future.
In addition, commodity-based stablecoins can be used to hedge against inflation, as their value is less likely to be affected by inflation than fiat currencies.
Final thoughts
Stablecoins are becoming increasingly popular among businesses and individuals, so it’s worth keeping an eye on their development over the next few years. All in all, stablecoins have great potential to revolutionize the way we use money in the digital age. The future of stablecoins looks bright, and it will be interesting to see how they evolve over the next few years. For now, though, it’s safe to say that stablecoins are here to stay. So, you've made it to the end of this article. Congratulations! We hope this article has given you a better understanding of stablecoins and how they work. Stay tuned!
To see ways on how you could deploy a token ERC-20 read through our [Docs] for more information on blockchain development! 🔚😁
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