The value of money can often be volatile and unpredictable. It can skyrocket one day and plunge the next. This turn in a currency’s value is typically determined by how strong or weak an economy is and unfortunately, this uncertainty can put everyone’s wealth at risk.
Usually, investors use precious metals, exclusive real estate, and other valuable assets to preserve their wealth. But if you’re looking at doing things a little differently, a stablecoin is another excellent option to protect yourself from potential losses.
What is a stablecoin?
A stablecoin is another type of digital token or cryptocurrency that attempts to mimic or peg its market value to another asset or external reference. Its price may be pegged to the price of commodities like gold, oil, gas, and other reserves or the value of government-issued money like US dollars, euro, yen, and more.
As a type of cryptocurrency, stablecoins also run their programs and operations through blockchain technology. They also aim to serve the same functions of traditional money and digital assets, which can be used for payment transactions. They fall under the category of payment tokens — used as a unit of account, medium of exchange, and store of value.
Some of the most popular among the list of stablecoins include Tether (USDT), Dai (DAI), USD Coin (USDC), TrueUSD (TUSD), Paxos Standard (PAXOS), and more.
However, unlike certain fiat currencies that are very susceptible to inflation, and other cryptocurrencies like Bitcoin (BTC) and Ethereum (ETH), which are known for being volatile assets, stablecoins are designed to maintain their value or achieve price stability. This is achieved in four different ways.
How do stablecoins work?
To bridge the gap between fiat money and cryptocurrency’s price stability, stablecoins peg their values using different mechanisms. Let’s take a look at its four categories.
1. Fiat-collateralized stablecoins
This type of stablecoin is backed by an existing government-issued currency, such as the United States dollar (USD), often with a 1:1 ratio. This means that equivalent fiat money is held as collateral for every digital coin issued to you. One good example is Tether (USDT), where 1 USDT is always valued at 1 USD.
Fiat-backed stablecoins are the most popular and widely used type of stablecoin in today’s crypto sphere. However, it’s considered vulnerable to fraud because they are issued by centralized groups and entities with their own rules and protocols. That’s why it’s important to look for an issuer you can trust.
2. Commodity-collateralized stablecoins
These stablecoins are similar to fiat-backed coins, but instead of fiat money, this type uses other kinds of interchangeable assets and goods as collateral. These include precious metals and minerals like gold, silver, and diamonds; valuable commodities like oil and natural gas; exclusive real estate, and many more. One good example of this is Venezuela’s oil-backed cryptocurrency called Petromoneda or Petro (PTR)—which cannot be traded internationally and has failed to gain any traction in the country.
3. Cryptocurrency-collateralized stablecoins
Here, instead of fiat money, the stablecoin is backed by cryptocurrencies. Since it uses cryptocurrencies as collateral, the entire process runs and operates on the blockchain in a decentralized manner. Often, crypto-collateralized stablecoins are pegged with a 1:2 ratio.
Because of cryptocurrencies’ highly volatile nature, a larger number of the coins will be held in collateral for every stablecoin. This way, the supply of stablecoins won’t be affected by extreme price fluctuations. An example of this is Dai (DAI), which is backed by collateral on the Maker platform.
However, because of the complexity of cryptocurrencies, this isn’t as popular as its fiat-backed counterparts. Also, because of the high amount held as reserves, it’s often referred to as “over-collateralized.”
4. Algorithmic stablecoins
Also referred to as non-collateralized, these stablecoins aren’t backed by either fiat money or cryptocurrency. Instead, they maintain stability through an algorithm or working mechanism. Smart contracts are in charge of managing the supply and demand scheme and guarantee stablecoin’s price stability.
The algorithmic system will generate new coins if the stablecoin is trading too high. Otherwise, the system will buy coins in the market to cut down its circulating supply. Examples of this are Primecoin (XPM) and the now-defunct Basis. This seems to be the most complicated one among the four, but the algorithmic systems are quite similar to central banks’ processes in managing supply.
Why are stablecoins important?
Like other cryptocurrencies, stablecoins also aim to provide developed functions of traditional money across the world. Let’s take a look at some of their significant benefits.
1. Price stability
Stablecoins are designed to have a stable value over any time. Because of this, a lot of crypto enthusiasts and investors consider them an ideal safe-haven asset. The value of fiat and cryptocurrencies could experience dramatic spikes and plunges at any time, which is why stablecoins are an excellent option for people looking for ways to preserve their wealth. They can store their wealth in an asset without seeing any risk of loss due to inflation.
2. Privacy and decentralization
Since stablecoins are a type of cryptocurrency, they also enjoy the same features and technology that make other digital assets like Bitcoin the most secure in the world. They run and operate on a blockchain, which prevents double-spending and hackers while allowing the network to be decentralized.
3. Programmable currency
Stablecoins are programmable and can be designed to fit the users’ needs since they are “fundamentally made up of code.” One common way of implementing this is through rewards or loyalty programs. If a company builds its program on top of its stablecoin, they can design an application where users can easily and quickly check their stablecoin and rewards at once.
Popular stablecoins on the market right now
Now that you know what they are and how they work, let’s take a deeper dive into this list of stablecoins many are using today:
As the name suggests, Tether is a stablecoin that’s pegged to the value of the US Dollar (1 USD = 1 USDT). It currently sits on the #3 rank among all cryptocurrencies on the market.
Value: 1.00 USD
Market cap: 82,557,675,749 USD
Maintained and regulated by MakerDAO, Dai is an Ethereum-based stablecoin that also pegs its value to the US Dollar by using collateralized debt—with its reserves not being held in US Dollars but instead through collateralized debt in ether (ETH).
Value: 0.9993 USD
Market cap: 9,401,706,542 USD
USD Coin (USDC)
USD Coin (USDC) is a stablecoin that’s fully backed by US Dollars—meaning that it’s a fiat-collateralized coin that’s pegged to USD.
Value: 0.9993 USD
Market cap: 50,960,698,150 USD
True USD (TUSD)
Like other examples on this list, True USD is a fully collateralized stablecoin verified by the Ethereum network. It also pegs its value to the US Dollar and maintains the 1:1 ratio, the way most stablecoins do.
Value: 0.9994 USD
Market cap: 1,345,160,168 USD
Pax Dollar (USDP)
Originally traded under the PAX ticker, it was later on rebranded to Pax Dollar (USDP) by the Paxos team. It’s also built on the Ethereum blockchain and maintains a 1:1 ratio with USD.
Value: 1.00 USD
Market cap: 946,559,515 USD
Unlike the other examples on this list, TerraUSD’s 1:1 ratio with the US Dollar is maintained through another cryptocurrency: LUNA—one that’s way more volatile than UST.
Value: 0.9997 USD
Market cap: 16,730,728,002 USD
*Data provided are accurate as of the time of writing: April 11, 2022
Why stablecoins work so well with Bitcoin
Since they are able to maintain their price, stablecoins appeal to people who want to protect the value of their money. However, when paired with a popular cryptocurrency like Bitcoin, you unlock the true potential of both. This way, you get the best of both worlds: investment opportunities plus real-use cases with Bitcoin and stability with stablecoins like Tether.
This is why we make it super convenient for you to convert USDT to BTC and vice versa on Paxful. Doing so will not only give you the opportunity to explore and experience the wonderful world of Bitcoin, but it will also allow you to protect your money from volatility with Tether.
Ready to experience the best of both worlds? Kickstart your journey and buy USDT on Paxful today!
Originally published on October 23, 2020 and updated on April 20, 2022