And even if they’re over-collateralized, crypto-backed stablecoins could run into trouble if other cryptos experience major downswings. First, you might want to keep money in the cryptocurrency system, but you don’t think it makes sense to invest in bitcoin (or a different cryptocurrency) right now. It’s a bit like keeping cash in a brokerage account while waiting to make an investment. Government agencies have discussed ways to regulate stablecoins, and have taken action against organizations that may have misrepresented their reserve holdings. And stablecoin issuers may share some details about what and where they’re holding their reserves.

what is a stablecoin and how it works

They’re often pegged (i.e., have a fixed exchange rate) to a fiat currency, such as the US dollar. The credit and lending markets are likely to see a surge in the use of stablecoins and no longer be dominated by government-issued fiat currencies. Algorithmic stablecoins pave the way for the use of automatic smart contracts on the blockchain network, enabling transparent, fast, and traceable transactions in loan payments and subscriptions.

What are stablecoins?

However, Tether does not disclose the breakdown of commercial paper it holds. If it is not well-diversified, debt exposure to a single company or sector could pose a significant risk. They’re a “safe haven in the wild world of crypto,” said Manuel Rensink, director of strategy and innovation at crypto company Securrency. Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more – straight to your e-mail. We break down the different types of this emerging investment and explain its risks. All up, you’re probably better off putting your money into a diversified (traditional) portfolio, or a legitimate crypto ETF, if you believe the crypto sector has legs.

what is a stablecoin and how it works

These stablecoins use a computer algorithm to keep the coin’s value from fluctuating too much. If the price of an algorithmic stablecoin is pegged to $1 USD, but the stablecoin rises higher, the algorithm would automatically release more tokens into the supply to bring the price down. If it falls below $1, it would cut the supply to bring the price back up. How many tokens you own will change, but they will still reflect your share. One algorithmic stablecoin is AMPL, which its creators say is better equipped to handle shocks in demand.

Stability amid the volatility of crypto: Stablecoins explained

These utility benefits may include fast and straightforward international money transfers without the expensive fees charged by banks. For crypto investors, stablecoins are particularly attractive right now because the prices of all cryptocurrencies tend to be volatile. In this sense, stablecoins offer a ‘safe haven’ for those looking to avoid market volatility. Stablecoins can also be ‘staked’, allowing owners to earn yields on holdings while avoiding the ups and downs of crypto prices. Collateralized by cryptocurrency – although technically with this option price volatility is still an issue, providers are trying to solve this by “over-collateralization”. The aim is to create a balance between the benefits of decentralization while the crypto reserves absorb the impact of market volatility.

Stablecoins attempt to peg their market value to some external reference, usually a fiat currency. 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.

Is stablecoin a cryptocurrency?

Commodity-backed stablecoins are backed by the value of commodities, such as gold, oil, diamonds, silver, and other precious metals. The most popular commodity to be collateralized as a backing asset is gold; Tether Gold (XAUT) and Paxos Gold (PAXG) are the most common examples here. The stablecoins segment has developed significantly over the past year.

what is a stablecoin and how it works

Tether, originally launched as RealCoin in 2014 was the first ever stablecoin. Tether is the largest and most well known stablecoin in the crypto market, with a total market cap of $77.5 billion USD ($107.9 billion AUD). The stated purpose of USDT is to combine the unrestricted nature of cryptocurrencies — which can be sent between users without a trusted third-party intermediary — with the stable value of the US dollar.

What’s Next for Stablecoins?

While the dollar’s purchasing power could change over time, it’s much less volatile than cryptocurrencies. And that’s the most positive side of stablecoins, but they also have their gray areas, which we’ll discuss later after telling you about the types of stablecoins that exist. Past performance is not a guarantee or predictor of future performance. The value of crypto assets can increase or decrease, and you could lose all or a substantial amount of your purchase price.

Serving the purpose of maintaining value and purchasing power, pegging against an asset can make stablecoins more resilient to market fluctuations in the cryptocurrency space. For instance, one of the most popular stablecoins — Tether (USDT) — is commonly equal to US$1. Cryptocurrencies can see significant price fluctuations over a short period of time, which means a stablecoin pegged to a cryptocurrency facing volatility could also witness extreme swings in value. The assumption is that stablecoins can be readily redeemed or traded for the value of the asset they’re pegged to. While some stablecoins are backed by tangible assets—PAX Gold, for instance, is backed by gold bullion bars stored in vaults—more volatile cryptocurrencies back others. Stablecoins are cryptocurrencies whose values are tied to those of real-word assets such as the U.S. dollar.

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