How do Stablecoins Work?

Cryptocurrencies have been the talk of the world for years now. Bitcoin have made the headlines for better or worse and become the hottest investment opportunity at the same time. Everyone’s willing to invest in crypto nowadays, with the volatility being cited as the main concern. As many of you know, Bitcoin’s price goes up and down all the time, and huge drops lead to sudden loss of value, especially if you invest a lot.

Is there a solution to this? No, that’s the nature of decentralized finance. On the other hand, you can put your money in stablecoins instead. By definition as found on learncrypto.com, these are cryptocurrencies tied to fiat money assets such as the US Dollar. In this guide, we’ll tell you more about how they work and why they’re a worthy investment.

What are Stablecoins?

Unlike cryptocurrencies that aren’t pegged to any other asset, stablecoins are linked to assets such as USD. This guarantees that their price won’t vary too much like in the case of Bitcoin. Such a combination offers the best of both worlds – you’re still enjoying the privacy and speed of cryptos without the volatility.

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They are always backed by one asset or another, be it USD or gold. They achieve their stable price by backing or via advanced algorithmic mechanism – buying or selling.

Why are stablecoins a good investment option? Well, they don’t experience the price swings Bitcoin does. For example, BTC can go 10% or more up or down in just the span of a few hours. While that can have a positive effect on your crypto wallet, it can also be devastating, especially for short-term traders. The volatility is completely eliminated by stablecoins, which are the digital version of many traditional currencies or assets.

Stablecoins are trying to bridge the gap between fiat money and crypto. They come in three different shapes and sizes, ultimately all collateralized in different ways.

Crypto-Collateralized Stablecoins

You might guess yourself what these are – stablecoins backed by other cryptos. For example, DAI is pegged against the USD and backed by Ethereum, allowing investors to use a basket of cryptos as a reserve.

Fiat-Collateralized Stablecoins

These stablecoins are backed by fiat money assets. The majority of them are pegs to the USD, keeping a stable price of $1.

Non-Collateralized Stablecoins

The rarest stablecoins include a working mechanism like a central bank to keep the price stable. Basecoin, for example, uses a consensus mechanism that increases or decreases the token supply on a need basis.

The Most Popular Stablecoins on the Market

The stablecoin market is constantly on the rise. They’re always under the scrutiny of regulators such as the British Treasury. That’s because of the growing market that has just hit $130 billion and rising.

The biggest draw among them all is Tether (USDT) which is tied to the US Dollar. It’s the most commonly accepted stablecoin at online merchants and in casinos, keeping a table price of $1. Tether tokens were developed by crypto exchange BitFinex. As of now, USDT is the fifth-largest cryptocurrency by market capitalization, showing you how big it is.

Binance USD (BUSD) is another important stablecoin. Used for transactions made on the Binance network, it keeps a steady price and is a highly valued stablecoin on the market.

The USD Coin is completely backed by US Dollars as well as dollar-denominated assets. Contrary to popular belief, it is not issued by the US government.

Other popular coins include the CBDC (Central Bank Digital Currency) as well as Terra.