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What is a stablecoin? Everything you need to know

what is a stablecoin

Some even use complex algorithmic programs to maintain the peg by controlling supply, although this doesn’t always work. TerraUSD (UST) was the biggest algorithmic stablecoin, reaching a market cap of more than $18.7 billion at its peak on May 5 before it began to plummet sharply after it slipped below its peg. The idea behind stablecoins is to help reduce some of the volatility seen in other cryptocurrencies. A widely held stablecoin could be a key stepping stone to mass crypto adoption. To serve as a medium of exchange, a currency that’s not legal tender must remain relatively stable, assuring those who accept it that it will retain purchasing power in the short term.

That makes them suitable both for acquiring volatile cryptocurrencies and for shifting out of them in case the price falls. Crypto-collateralized stablecoins are backed by other cryptocurrencies. Because the reserve cryptocurrency may also be prone to high volatility, such stablecoins are overcollateralized—that is, the value of cryptocurrency held in reserves exceeds the value of the stablecoins issued. If the price falls below the value of the fiat currency, the token supply is reduced and vice versa. Dai (DAI) is the fourth largest stablecoin by market cap and is pegged to the U.S. dollar on a one-to-one basis. Unlike the three stablecoins mentioned above, DAI is not backed by U.S. dollars but by a combination of various crypto assets.

What Kinds of Stablecoins Are There?

They are more useful than more-volatile cryptocurrencies as a medium of exchange. Stablecoins may be pegged to a currency like the U.S. dollar or to the price of a commodity such as gold or use an algorithm to control supply. They also maintain reserve assets as collateral or through algorithmic formulas that are supposed to control supply. The technical implementation of this type of stablecoins is more complex and varied than that of the fiat-collateralized kind, which introduces a greater risk of exploits due to bugs in the smart contract code. With the tethering done on-chain, it is not subject to third-party regulation creating a decentralized solution.

what is a stablecoin

In the UK, the Bank of England has warned that stablecoins must face “difficult questions”. The Financial Action Task Force noted last year that the mechanisms for stabilising the assets could present avenues for market manipulation. Stablecoins can allow investors to move in and out of different cryptocurrencies while staying within the cryptocurrency realm.

Failed and abandoned stablecoin projects

In the US, the President’s Working Group on Financial Markets, led by the Treasury, released a report in November which called on Congress to legislate to regulate stablecoins as banks. What this means is that a stablecoin pegged to, say, the U.S. dollar on a one-to-one basis should always be equal to $1. Karl Montevirgen is a professional freelance writer who specializes in the fields of finance, cryptomarkets, content strategy, and the arts. Karl works with several organizations in the equities, futures, physical metals, and blockchain industries. He holds FINRA Series 3 and Series 34 licenses in addition to a dual MFA in critical studies/writing and music composition from the California Institute of the Arts.

what is a stablecoin

A stablecoin is a type of cryptocurrency whose value is pegged to something like the US dollar or gold. What it is pegged to can vary, but the idea is that by linking the value of the digital asset to something else the price will be more stable than the price of other types of crypto. Algorithmic stablecoin issuers can’t fall back on such advantages in a crisis. A cryptocurrency worth $2 million might be held as reserve to issue $1 million in a crypto-backed stablecoin, insuring against a 50% decline in the price of the reserve cryptocurrency. For example, MakerDAO’s Dai (DAI) stablecoin is pegged to the U.S. dollar but backed by Ethereum (ETH) and other cryptocurrencies worth 150% of the DAI stablecoin in circulation.

Types of Stablecoins

Counterparty risk is the probability that the other party in the asset may not fulfill part of the deal and default on the contractual obligation. Due to the potential for losses, the Financial Conduct Authority (FCA) considers this investment to be high risk. Adam Hayes, Ph.D., CFA, is a financial writer with 15+ years Wall Street experience as a derivatives trader. Besides his extensive derivative trading expertise, Adam is an expert in economics and behavioral finance.

what is a stablecoin

There are three types of stablecoins, based on the mechanism used to stabilize their value. Collateralised stablecoins maintain a pool of collateral to support the coin’s value. Whenever the holder of a stablecoin wishes to cash out their tokens, an equal amount of the collateralising assets is supposed to be taken from the reserves. The biggest example in this category is the DAI (DAI) algorithmic stablecoin, which is pegged to the U.S. dollar but is backed by Ethereum and other cryptocurrencies. Collateralized stablecoins maintain a pool of collateral to support the coin’s value.

What differentiates stablecoins from cash?

However, Coinbase does not charge commission fees when UK customers buy or sell USDC1. There is now a growing belief among regulators that the whole sector needs to be reined in because of risks around consumer protection, the effectiveness of monetary policy and the stability of the financial system. Circle and Coinbase committed to ensuring that USD coin would be fully backed by cash and treasuries (government bonds) by the end of September, which their attestations for the month show.

  • They are now supported by more cryptocurrency service providers than ever before, with a market capitalisation of just under $ 25 billion.
  • For example, MakerDAO’s Dai (DAI) stablecoin is pegged to the U.S. dollar but backed by Ethereum (ETH) and other cryptocurrencies worth 150% of the DAI stablecoin in circulation.
  • This site does not include all companies or products available within the market.
  • According to its partner developers, Binance and Paxos, BUSD is 100% backed by an “equal amount” of U.S. dollars and treasury bills.

USDC’s reserves are held in safe assets that should retain their value, such as cash and U.S Treasurys. Here’s a general guide to understanding the different stablecoins available on the market what is a stablecoin today. One of the risks of a stablecoin is that it can “depeg” from its collateral value. Usually, you expect to pay a transaction fee when buying or selling cryptocurrencies with an exchange.

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