4 types of stablecoins
Cryptocurrency market with strong volatility and fluctuation in the short and long term has made many people hesitate to access it. As such, stablecoin has been considered as a bridge to connect crypto space with traditional finance with its stability feature. In this article, we would take a closer look at stablecoins to give you a deeper understanding of what exactly is stablecoin and the four types of stablecoins. Let’s find out with Tokenize Xchange!
When stablecoins are mentioned, most of you might think of Tether (USDT) as the only stablecoin in the cryptocurrency market. But it’s not true! USDT is just one of numerous stablecoins existing in the market that we would introduce to you in this article.
What is stablecoin?
Stablecoin is a type of cryptocurrency created with the aim of minimizing the impact of volatility by pegging to a range of stable assets such as real money (fiat money), commodities (gold, silver), or other cryptocurrencies. Stablecoins are based on blockchain and peer-to-peer transfer while users are not subject to high volatility like from other cryptocurrencies.
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There are some different methods to realize and maintain stablecoin’s price peg to the underlying assets. For example, USDT pegged to 1-to-1 to the USD (1 USDT = 1 USD); and DGX pegged against physical gold (1 DGX = 1 gram of gold).
4 types of stablecoins
As mentioned above, the stability of stablecoins results from pegging to a range of stable assets. Hence, we could divide stablecoins into 4 types based on their underlying assets, or collateral as below.
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Fiat-backed stablecoin is a cryptocurrency built on the value of a fiat currency that is held by a third-party financial entity. The cost to maintain the stability of the stablecoins is equal to the cost to maintain the backing reserve. Among the 4 types of stablecoins, fiat is the most common fiat collateral for stablecoins. Below are some examples of fiat-backed stablecoins:
Commodity-backed stablecoins are cryptocurrencies tied to the value of precious assets such as gold or silver. The value of these stablecoins are pegged to one or more commodities and redeemable on demand. Also, the amount of commodities used to back stablecoins must reflect the circulating supply of the cryptocurrency. Below are some examples of commodity-backed stable coins.
An example of commodity-backed stablecoins is DGX (Digix Gold Tokens)
Similar to fiat-backed stablecoins, crypto-backed stablecoins use other digital cryptocurrencies as collateral. However, the difference between the two concepts is that fiat collateralization occurs off the blockchain while the backing crypto is built on the blockchain, using smart contracts.
Moreover, the supply of crypto-backed stablecoins is regulated on-chain with smart contracts. Also, the price stability of these assets can be executed with the participation of supplementary instruments and incentives, and not just the crypto collateral.
An example of crypto-backed stablecoins is DAI – the cryptocurrency backed on numerous digital assets such as BAT and ETH.
Among the 4 types of stablecoins, the algorithmic stablecoin is the only one that is based on no collateral. Instead, their price stability is the consequence of smart contracts and specialized algorithms. The algorithm mechanism would reduce the circulating supply of the tokens when the market price drops below the price of its tracking fiat currency. In contrast, when the crypto price exceeds the tracking fiat price, new tokens will be added to lower the stablecoin price.
Top stablecoins based on market cap:
In conclusion, most cryptocurrency investors might agree that keeping one or two stablecoins in your portfolio is a smart move to diversify and protect your investment. Also, stablecoins help you move quickly out of dumping crypto and reinvest. Moreover, stablecoins could improve the liquidity of crypto exchanges and work as the medium of exchange for risk-averse traders and investors.
So, what do you think of stablecoins? Do you hold it, or consider it as an investment? Don’t hesitate to share with Tokenize Blog and see you in the next article!
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