Crypto Primer: What are Stablecoins? | cryptopolitan

As you dive deeper into the world of cryptocurrencies and crypto investments, you will likely come across a term called “stablecoins”. But what does it really mean and are there any good examples worth noting? Read on as we shed some light on the matter.

  1. Stablecoins in brief

Before we can give you the definition of stablecoins, we need to start with an overview by covering the basics and asking what is crypto? Essentially, cryptocurrencies are digital currencies that allow for streamlined transfers without having to rely on a third party like a financial institution to oversee them. In other words, they are closely related to the concept of decentralized finance.

However, the value of cryptocurrencies tends to fluctuate quite a bit as it is tied to the amount of capital people have invested in them. Here is where stablecoins come into play; by being independent of market volatility and price fluctuations, they retain all the advantages of traditional cryptocurrencies without introducing some of the disadvantages.

  1. The value of stablecoins is tied to another commodity

Now that you know how stablecoins work, you’re probably wondering what defines their value? Simply put, their value is directly tied to the value of another commodity like the US dollar or gold.

A traditional crypto coin like Bitcoin can go up and down, hitting crazy highs like $68,000 and then hitting a third of its peak value a few months later. In other words, it might be great for market speculators and investors, but as a medium of exchange, it’s less than ideal. Hence, stablecoins came into being.

  1. The different types of stablecoins

Stablecoins are categorized based on the underlying mechanism that regulates their value. A stablecoin can fall anywhere into the following categories:

  1. 1. Stablecoins backed by Fiat

As the name suggests, this type of stablecoin has its value pinned to a fiat currency such as the US dollar. Attached (USDT) is an example. In fact, these fiat currencies are used as collateral and are under constant scrutiny by auditors.

  1. 2. Crypto-backed stablecoins

Instead of using fiat currencies as collateral, their function is replaced by other cryptocurrencies. Now, since cryptocurrencies tend to be volatile in nature, how does this work? The answer is that the value of cryptocurrencies held in reserves must be greater than that of stablecoins. This way, even if the value of the cryptocurrencies drops by a substantial amount, they can still be used to cover the original amount.

  1. 3. Algorithmic stablecoins

Algorithmic stablecoins stand out the most because they are not necessarily tied to reserve assets. Instead, an algorithm runs in the background that ensures their value doesn’t fluctuate too much. In a way, this is similar to what central banks do.

The value of stablecoins is usually tied to a commodity like the US dollar

  1. Are stablecoins regulated?

In 2021, the International Organization of Securities Commissions decided that, like payment systems, stablecoins should be regulated. Regulators are mainly focusing on stablecoins that could disrupt the financial system.

At the same time, various politicians have expressed their concerns, putting increasing pressure on the regulation of stablecoins. Senator Cynthia Lummis, for example, wants stablecoin issuers to be audited regularly.

  1. Conclusion

Stablecoins are the answer to traditional cryptocurrencies and their inherent market volatility. By having their value tied to a more stable commodity such as fiat currencies or gold, they are not susceptible to market fluctuations and are therefore more suitable for use as a medium of exchange.

If you’re inspired by the idea of ​​decentralized finance but don’t particularly like the risks of investing in traditional cryptocurrencies, stablecoins might be a good place to look.

#Crypto #Primer #Stablecoins #cryptopolitan #Crypto

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