Home Cryptocurrency How Stablecoins Remain Stable Explained

How Stablecoins Remain Stable Explained

by Gordon James

In this post, I’ll offer a primer on what the ‘stable coin’ is and how it’s different from other cryptocurrencies. To simplify things for you, let me provide some examples of stable coins: Tether (USDT), TrueUSD (TUSD), Dai (DAI).

The “stablecoin regulation” is the process of regulating a cryptocurrency to make sure that it remains stable. The most common way to regulate a cryptocurrency is by using a central bank or other financial institution.

 

Since Bitcoin’s first price increase, the cryptocurrency market has seen severe volatility. The coins’ pricing was constantly volatile since there was nothing in the actual world to support them. The amount that the price of the coins would increase or decrease has been influenced by supply, demand, market attitude, different events, adoption rate, and other factors.

While this did provide a big opportunity for profit, it also presented a significant risk of loss for any investor who chose to act incorrectly. Additionally, it implied that traders and investors would either have to wait a very long time for prices to rebound or sell their coins for fiat as soon as they began to decline. With just a few alternatives to safeguard your cash, this was not a very practical approach and made cryptocurrency rather hazardous.

Finding a solution necessitated the development of a new kind of currency, one that would be resistant to volatility and abrupt price swings. The most crucial characteristic of this new currency type, price stability, is right there in the name: stablecoin.

Stablecoins: What are they?

Stablecoins are cryptocurrencies that can maintain their price at the same level despite market trends, volatility, supply and demand, and other factors that often affect the value of a digital currency. In the sense that they function as digital currencies built on top of blockchain technology, they are cryptocurrencies.

Stablecoins may be used to send payments instantly and immutably to any location in the globe, much like other digital currencies. However, the crypto business has seen a significant shift as a result of its capacity to maintain a set price.

Suddenly, the cryptocurrency market gained access to a resource that may serve as a refuge in times of extreme volatility—a place to go when the negative wave hits and prices begin to decline. In order to protect their wealth and maintain it inside the crypto business, the whole crypto community decided to purchase them during significant price decreases rather than having to exchange their coins for fiat money.

How are stablecoins operated?

Stablecoin operation is rather straightforward. In essence, all that is required is for each coin to be backed by a different asset. This may be actual products like oil, gold, silver, and the like, or it can be fiat currencies like the USD, GBP, EUR, and similar ones. Finally, stablecoins may serve as so-called algorithmic stablecoins, which are by far the most complicated, or they can be backed by other cryptocurrencies.

With that stated, let’s now examine each of these many stablecoin kinds and see how it functions.

1. Stablecoins backed by fiat

Stablecoins that are backed by currency come first. These stablecoins, which rely on fiat currencies to keep their values stable, are by far the most prevalent and commonly utilized ones. They operate in a very basic manner. The only requirements for stablecoin issuers are to produce their coins and demonstrate that they have the funds on hand to fully back each coin.

The issuer’s account must have sufficient funds to cover the currency’s supply since these stablecoins are often tied to the USD, where 1 coin = $1. In other words, there must be $1 million in the issuer’s account for every million coins in circulation.

The price per coin would decrease if there were more coins than money in the account. The price of the coin would rise if there were fewer coins than dollars in the account. Of course, in order to seem trustworthy and for their stablecoin to be actually dependable, stablecoin issuers need to be extremely clear with how much money they have.

Tether (USDT), the third-largest cryptocurrency by market size and by far the biggest stablecoin in the industry, is an example of this kind of coin. Then there are additional currencies, such Binance USD (BUSD), USD Coin (USDC), and others.

2. Stablecoins backed by crypto

Stablecoins backed by crypto are the next option. One cryptocurrency or perhaps a whole basket of them may be used to back these. Due to the tremendous volatility of cryptocurrencies, which is what gave rise to stablecoins in the first place, these coins have a tendency to be rather overcollateralized. The crypto industry’s demand for decentralized stablecoins is the only explanation for why these stablecoins even exist.

They operate in a rather straightforward manner. Users must secure their collateral tokens in a smart contract in order to create stablecoins. If the value of the collateral declines, it is liquidated to reflect the price change. And all you have to do to get your collateral back is give the stablecoins back.

MakerDAO’s DAI is among the greatest illustrations of this sort of currency. DAI is anchored to $1 much as stablecoins based on fiat currency.

Overall, this is a solid method for creating decentralized stablecoins, but its major drawback is that it relies on digital currencies, which may sometimes be so volatile that even a stablecoin with excessive collateral is at risk.

3. Stablecoins backed by assets

Commodity-backed or asset-backed stablecoins are the third kind of stablecoin. These stablecoins, as previously indicated, are backed by real-world assets like precious metals, real estate, or other assets that have market value and may, thus, be utilized to provide assets to the stablecoin.

These are explicitly connected to a specified quantity of the commodity and kept in a recognized place, much as stablecoins are backed by fiat currencies. Physical items may be sold, stolen, or destroyed depending on how they are utilized, thus they must also be routinely audited.

The most well-known example of this form of stablecoin is Pax Gold, which was developed by Charles Cascarilla, the CEO of Paxos, and is based on Ethereum. This coin is backed by one fine troy ounce of London Good Delivery gold that is kept in a London gold vault that has received LBMA approval from Brinks.

Another example would be the cryptocurrency called Petro, which was introduced in early 2018 and is supported by Venezuela’s oil reserves. However, owing to the fact that Petro was developed by the president of the nation, who has been attempting to convince his countrymen to convert to the coin in order to combat hyperinflation, most people do not believe it to be a true cryptocurrency, much less a stablecoin. However, the general public preferred using ordinary cryptocurrencies over this stablecoin and never really showed much interest in it.

4. Computerized stablecoins

Not least among these are algorithmic stablecoins. These stablecoins are the most intricate since they depend on algorithms and smart contracts to maintain their price stability.

In essence, they regulate the stablecoin’s supply using algorithms and smart contracts. They adjust it as necessary in order to keep the pricing constant. This indicates that there is no collateral backing these coins in any way. Instead, they have a fixed value but fluctuate in quantity in line with the price of the fiat currency they follow.

In essence, it may be tied to any fiat currency, whether it is the dollar, the euro, or another one. The algorithm will swiftly take tokens out of circulation if the stablecoin market price begins to drop below that level. The value of the tokens will return to normal since there will be less of them today. In the opposite circumstance, the same holds true. The algorithm will simply add additional stablecoins to circulation to avoid a price spike if the stablecoins start to experience a gain in value.

This kind of stablecoin is perhaps the most decentralized type available, while being the most sophisticated. It’s all fully automated, so it doesn’t rely on how much money or other assets the issuer has on hand, and it doesn’t run the danger of losing value if a sudden bearish wave drives the price of a collateral coin down.

This kind of stablecoin could become the most common in the future since it doesn’t have any of those drawbacks. However, for the time being, the business continues to rely mostly on centralized currencies, since they are the most dependable, assuming that their issuer can be believed.

Conclusion

When the market is in a bear market and cryptocurrency users need a secure location to put their money, stablecoins have shown to be a highly helpful sort of cryptocurrency. Additionally, they are quite practical, often coupled with the majority of currencies, if not all coins, on every exchange where they are listed.

There are several kinds, as we’ve seen in this book, and although some are better than others, ultimately they all work to help you remain in cryptocurrency even when the market is negative.

The “how does usdt stay stable” is a question that has been asked many times. In this article, I will explain the answer to how Stablecoins remain stable.

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