A stablecoin is a cryptocurrency unit whose value is linked to an external asset, such as the US dollar or gold to ensure price stability. Cryptocurrencies units like bitcoin and ether have several benefits, including that they don’t need a third party to send payments, making them available to people worldwide. On the other hand, Cryptocurrency values are highly volatile and fluctuate frequently. To maintain its value, a “stablecoin” is a cryptocurrency whose value is linked to another asset class, such as fiat cash or gold.

Cryptocurrency’s unpredictability contrasts with the relatively steady pricing of traditional money such as US dollars or other assets such as gold. This makes them challenging for ordinary people to use. People, in general, want to know how much their money is worth in a week for security and livelihood reasons. 

Stablecoins are a type of cryptocurrency unit.

Stablecoins try to reduce price volatility by tying the value of cryptocurrencies to more stable assets like fiat currency. Fiat, a cryptocurrency unit, such as dollars or euros, is a government-issued currency. To back up one million stablecoin units, the company behind the stablecoin will often set up a “reserve” where the asset or basket of assets backing the stablecoin is securely maintained.

One way to link digital stablecoins to real-world assets is to use this strategy. When a stablecoin holder wants to cash out their tokens, the reserve is depleted by an equal quantity of the investment that backs it. A more advanced stablecoin is supported by other cryptocurrencies rather than fiat currency but still aims to track a popular asset such as the dollar.

Maker, arguably the most well-known stablecoin issuer, does so using a service called “Vault” (formerly known as a Collateralized Debt Position). Maker encrypts a user’s cryptocurrency collateral. Once the collateral has been secured, the smart contract can borrow the newly produced dai, the stablecoin.

The third sort of stablecoin is an algorithmic stablecoin, which is not collateralized and instead relies on coins being destroyed or generated to keep the coin’s value in line with the target price. The program will burn a batch of coins to create scarcity and thus raise the price of the stablecoin. Assume the cost of the stablecoin drops from $1 to $0.75. This type of stablecoin unit is challenging to master, and several attempts in recent years have failed. Entrepreneurs, on the other hand, persist in their efforts.

Collateral for stablecoins comes in a range of shapes and sizes. One of the few operational implementations of this architecture is UST, founded by blockchain project Terra. This architecture is used to create several stablecoins, and collateralized stablecoins use a range of assets as backing:

Fiat: Fiat is the most common type of collateral for stablecoins. The US dollar is the most widely used fiat currency. Still, businesses are also interested in stablecoins tied to other fiat currencies, such as BiLira, which is connected to the Turkish lira.

Precious metals: The price of precious metals such as gold or silver is linked to the worth of many cryptocurrencies.

Cryptocurrency Units: Cryptocurrencies such as ether are collateral in some stablecoins.

Other investments: Tether’s USDT was initially supposed to be backed 1:1 with dollars, but the company’s collateral composition has changed over time, with over half of its reserves in commercial paper, a sort of short-term business debt, according to a 2021 breakdown. It has not revealed the paper’s issuers. Still, it claims they are all rated A-2 or above (A-2 is the second-highest credit rating available from credit rating organizations such as Standard & Poor’s for a corporate borrower). Circle’s USDC lists undefined “authorized investments” alongside accounts with federally insured banks in its monthly disclosures (note, it does not say whether the funds are insured).

In this video, https://t.co/LwaCbypcKu founder Arnab Naskar tells us why the world needs #Tether pic.twitter.com/0lepbGAOMX

— Tether (@Tether_to) March 18, 2022

How different are they from the cryptocurrency units?

Many of us have been tempted to invest in digital assets due to the rising demand for bitcoin and the increasing use cases that investors have recognized. Large profits in recent years by currencies like bitcoin and other cryptocurrency units have fueled demand, making the market even more volatile. How can one minimize risk while maximizing return in such a market? This is where stablecoins come into play.

Said, stablecoins are cryptocurrencies with low volatility and price stability, as they are backed by cash and cash assets, ensuring that their prices are predictable with minimal risk. 

Cryptocurrency units are highly volatile, rising and falling in distinctive ways. Stablecoins eliminate this problem. However, because a stablecoin is backed by fiat currency, it begs whether it is a cryptocurrency or a digitized version of fiat currency. Stablecoins exist in the grey area between the two worlds, taking parallels from both. Your guess is likely to be the same as ours.

Also, read – Users can Now Trade Stablecoins on Phemex

Fiat-backed stablecoins are bound by all of the constraints of fiat currency, jeopardizing the conversion process’s efficiency and the digital asset’s potential efficacy. Facebook’s Libra currency, for example, offered a stablecoin backed by a portfolio of global fiat currencies, extending the coin’s appeal and value. However, the project’s administration was forced to abandon it due to regulatory criticism. The network is still working with regulators to get its stablecoin approved. Not only that, but all stablecoins are subject to third-party laws, making them extremely difficult to join the actual decentralization movement.

Stablecoins are beneficial since they make cryptocurrency unit transactions easy for users. They provide a bridge between volatile cryptocurrencies and real-world assets like fiat money. You are allowed all of your transactions within crypto exchanges by exchanging stablecoins instead of US dollars, avoiding the fees that many exchanges impose, and maintaining transaction anonymity. Stablecoins serve as a link between cryptos that run on various networks, eliminating the need for users to convert to fiat cash.

Stablecoins are fantastic intermediaries for the decentralization movement, but their value is generated from fiat currency, commodities, other cryptocurrencies, or algorithms. Hence they may not be accepted into the mainstream cryptocurrency family. It began to lessen the volatility of cryptos has evolved into a supporter of decentralization. The point of having a cryptocurrency is null and void when it is backed by fiat currency, as it loses its independence.