What Accurately Is A Stablecoin?

Stablecoins are coins backed by a reserve asset like gold or silver. It combines the benefits of both cryptocurrencies and fiat currencies, such as rapid payment processing, security, and anonymity.

Key Point
  • Stablecoins try to tie their market value to an external reference.
  • Stablecoins are backed by a currency like a dollar or a commodity like gold.
  • Stablecoins establish price stability by collateralization (backing) or algorithmic trading of the reference asset or derivatives.
Stablecoins Explained
While Bitcoin (BTCUSD) is the most popular cryptocurrency, its value is very volatile. 
For example, it soared from roughly $5,000 in March 2020 to over $65,000 in April 2021 before plummeting bover 50% to around $30,000 in June 2021.
Even intraday price fluctuations may be extreme, with the cryptocurrency sometimes jumping more over 10% ieither direction within few hours.
That makes Bitcoin and other popular cryptocurrencies unsuitable for daily usage by the general population. 
currency’s value should be generally steady throughout time, and it should operate as means of trade and store of value. 
Users will not embrace it if they are uncertain about its buying power.
Ideally, crypto coin’s buying power and inflation rate should be low enough to incentivize consumption rather than conserving. 
Stablecoins help achieve this desirable behaviour.
Stablecoins are classified into many categories
Fiat currencies (for example, the US dollar), in which the currency is supported by the government’s complete confidence and credit it, have a certain allure for investors.
Fiat currencies benefit from some price stability as a result of this. However, this also implies that many fiat currencies are essentially controlled by their own central banks.
It is the goal of stablecoins to bridge the gap that exists between fiat currency and cryptocurrencies. Stablecoins may be divided into three kinds, each of which is dependent on the method by which they operate.
Stablecoins that are collateralized by fiat currency

To issue an appropriate quantity of crypto coins, fiat-collateralized stablecoins retain a fiat currency reserve, such as the U.S. dollar, that may be used as collateral.

Precious metals like gold or silver and agricultural commodities like oil may also be used as collateral. However, most fiat-collateralized stablecoins in circulation today are backed by dollar reserves.

Such reserves are managed by independent custodians who are subjected to regular audits to ensure that they conform to the applicable regulations. Among the most popular cryptocurrencies are the USDT USD and TrueUSD (TUSDUSD), both of which have a value equal to that of a single United States dollar and are backed by dollar deposits.

Fiat-backed stablecoins

To issue enough crypto coins, fiat-collateralized stablecoins keep a fiat currency reserve, such as the US dollar, as collateral. Collateral might be precious metals like gold or silver or agricultural commodities like oil. To be fair, most stablecoins today are backed by dollar reserves.

These reserves are administered by independent custodians who are regularly audited to guarantee compliance. Among the most popular cryptocurrencies are USDT USD and TrueUSD (TUSDUSD), which are backed by dollar deposits.

ALGO Stablecoins (non-collateralized)

Unlike a central bank, non-collateralized stablecoins employ a functional mechanism to maintain price stability. For example, the dollar-pegged basecoin employs consensus to raise or reduce token supply based on demand.

Similar to a central bank producing banknotes to sustain fiat currency values. A decentralised platform with autonomous smart contracts can do this.

Regulation of Stablecoins

In light of the $130 billion market cap of stablecoins and their potential to have an influence on the larger financial system, authorities continue to closely monitor the cryptocurrency.

When the International Organization of Securities Commissions (IOSCO) issued their recommendation in October 2021, it said that stablecoins should be regulated as financial market infrastructure, alongside payment systems and clearinghouses.

In particular, the proposed restrictions would target stablecoins that authorities consider to be systemically significant and that have the potential to cause disruptions in payment and settlement processes.

Furthermore, legislators have stepped up their requests for tighter stablecoin monitoring. For example, in September 2021, Senator Cynthia Lummis (R-Wyoming) asked for frequent audits of stablecoin issuers, while others advocate for rules similar to those governing banks in the industry (see below).

Leave a Comment