This stability is achieved through various mechanisms, such as collateralization, algorithmic adjustments, or centralization. Stablecoins are a type of cryptocurrency that can be purchased in a crypto wallet that aims to maintain a stable value by pegging it to an underlying asset or a basket of assets. There are several types of stablecoins, each with its unique mechanism for achieving price stability. Asset-backed stablecoins maintain reserves in non-blockchain assets. The safest options may be those that hold fiat currency in regulated accounts.
However, the problem with this approach is that it is controlled by a centralized company. As this model involves fiat currency, the issuing party must have a particular https://www.xcritical.com/ basic trust that they actually have the appropriate assets to pay out the tokens. Fiat currencies introduce serious counterparty risk for token holders.
Cryptopedia: Learn the concepts behind stablecoins and how they work
Despite its superior functionality and market-leader status, Tether has come under increasing legal scrutiny after repeatedly refusing audits and being found guilty of criminal activity. Tether was fined $41 million USD ($57 million AUD) and banned from practice in New York. Adam Hayes, Ph.D., CFA, is a financial writer with 15+ years Wall Street experience as a derivatives trader.
Instead, it uses automated algorithms to try to create or decrease supply and hold a steady price. However, these algorithmic or “seigniorage-style” stablecoins haven’t caught on. Stablecoins will not see an increase in value like Bitcoin has achieved this year. They are based on other values that https://www.xcritical.com/blog/what-is-a-stablecoin-and-how-it-works/ are not as volatile as the original cryptocurrencies and promise systematic passive crypto income. They can be easily bought through platforms like Changelly and will be a good addition to an investment portfolio. Stablecoins are great when you want to establish yourself some passive income.
Types of Stablecoins
If you’re curious about cryptocurrency, think about using some “fun money” — those dollars left over after you’ve built your savings and paid for essential expenses. If you’re looking to add some riskier assets to your portfolio, individual stocks can also fill that role. The smaller caps coins are more affected by everyday buy and sell orders compared to higher cap coins or even fiat currency like the US Dollar. Moreover, politicians have increased calls for tighter regulation of stablecoins. For instance, in November 2021, Senator Cynthia Lummis (R-Wyoming) called for regular audits of stablecoin issuers, while others back bank-like regulations for the sector. Stablecoins continue to come under scrutiny by regulators, given the rapid growth of the around $130 billion market and its potential to affect the broader financial system.
Other cryptocurrencies may fluctuate in value relative to, say, the U.S. dollar. In contrast, the price of a stablecoin should not change relative to the currency to which it’s pegged. A stablecoin worth $1 aims to maintain the price of $1; nothing more, nothing less. Fiat-backed stablecoins are the cryptocurrencies most closely related to fiat (or traditional) currencies because they are backed by real-world currencies.
What’s Next for Stablecoins?
With the number of new stablecoins being introduced, it is essential to have a good understanding of which stablecoins are the most cost-effective and investor friendly. Stablecoins aim to maintain their pegged rates using different means. Stablecoins can be backed by cash, cash equivalents, commodity values, or the value of other financial instruments to maintain their peg. Some even use complex algorithmic programs to maintain the peg by controlling supply, although this doesn’t always work. Recent events have taught us that not all stablecoins are created equal.
The advantage of this type of algorithmic stablecoins is that it is independent of other currencies. In addition, the system is decentralized as it is not under the control of a third party but is solely controlled by the algorithm. However, the problem with this approach is that the collateral intended to back the stablecoins is itself a volatile cryptocurrency. If the value of this cryptocurrency falls too quickly, the issued stablecoins may no longer be adequately secured. However, this would result in inefficient use of capital, and larger amounts of money would have to be frozen as collateral compared to the first model.
