A stablecoin is a type of cryptocurrency designed to maintain a stable value relative to a specific asset or a pool of assets. This is in contrast to other cryptocurrencies like Bitcoin or Ethereum, which are known for their price volatility. Stablecoins are typically pegged to a reserve of assets like fiat currencies (like the U.S. Dollar, Euro, etc.), commodities (like gold), or even other cryptocurrencies.
The goal of stablecoins is to blend the benefits of cryptocurrencies, such as blockchain-based transparency, security, and speed, with the stable value of traditional currencies. This can be beneficial for a number of reasons, including making transactions easier for everyday goods and services, acting as a safe haven in a volatile crypto market, and enabling more stable DeFi (Decentralized Finance) applications.
There are several types of stablecoins:
- Fiat-Collateralized Stablecoins: These are backed 1:1 by real-world assets like the U.S. dollar or euro. The reserve is held by a central entity and tokens can be issued or burned as more money is deposited into bank accounts or withdrawn. An example of this is Tether (USDT) or USD Coin (USDC).
- Crypto-Collateralized Stablecoins: These are backed by other cryptocurrencies. Because cryptocurrencies are volatile, these stablecoins are often over-collateralized to absorb large price swings. An example of this is DAI, which is pegged to the U.S. dollar but backed by Ethereum.
- Non-Collateralized (Algorithmic) Stablecoins: These are not backed by any collateral. Instead, smart contracts automatically expand and contract the supply of the non-collateralized stablecoin using algorithms, much like a central bank conducts monetary policy.
- Commodity-Collateralized Stablecoins: These are backed by other types of interchangeable assets, like precious metals. The most common commodity used is gold. An example of this type of stablecoin is PAX Gold (PAXG), where each token represents one ounce of gold stored in a vault.
Please note that the degree of stability provided by stablecoins can vary and depend on the effectiveness of the mechanisms that are in place to maintain the peg to the asset or assets to which the stablecoin is tied. They also come with their own set of risks, including the risk that the entity that holds the reserves could default or that the mechanisms for maintaining the peg could fail.