Stablecoins are a category of cryptocurrencies that aim to maintain a stable market value pegged to a particular, relatively stable reference asset, typically the U.S. dollar or gold.
This stability enables them to serve as a sound medium of exchange and store of value in the digital economy, connecting volatile crypto markets to traditional finance.
Once you get to know what are stablecoins, it’s time to gain insights into how they work and the top reasons why people use them. Let’s continue to read on…
Here’s How They Work
Stablecoins maintain their peg through various mechanisms, primarily categorized by their underlying collateral structure:
- Fiat-Backed Stablecoins
These are the most prevalent ones. A central issuer keeps an equivalent sum of fiat money (such as USD or EUR) and/or high-quality liquid collateral (such as short-term government securities) on reserve for every stablecoin issued. The underlying fiat can be redeemed by holders at a 1:1 ratio for their tokens, and an arbitrage mechanism helps maintain the market price at the peg.
- Commodity-Backed Stablecoins
Physical assets like gold, silver, or oil support these. A token usually corresponds to a claim to a specific amount of the commodity held in secure vaults This enables users to invest in commodities digitally without concern for physical storage.
- Crypto-Backed Stablecoins
These are secured by other cryptocurrencies rather than fiat or commodities, typically in a decentralized manner via smart contracts. To reduce the risk of the underlying crypto volatility, these stablecoins are generally overcollateralized (e.g. $150 of crypto supporting $100 of the stablecoin).
- Algorithmic Stablecoins
These stablecoins are supposed to maintain a fixed value without a reserve of a standard asset, and they use automated algorithms and smart contracts to regulate token supply in line with market demand. Whenever the price increases, the system mechanically issues new coins, and whenever the price decreases, it burns them. So, the supply is automatically adjusted to the price.
Top Reasons Why People Prefer Using Stablecoins
Individuals involved in stablecoins use them based on numerous factors, combining the advantages of blockchain technology with the certainty of conventional money:
- A Safe Haven from Volatility
During times of extreme market volatility, users can transfer their money into stablecoins. This transfer safeguard their capital without being completely deflated back into the traditional fiat world, keeping it in the crypto ecosystem for later trading.
- Quick, low-cost International Payments
Stablecoins facilitate almost-instant, low-cost international transactions and remittances by bypassing traditional, slow, and expensive banking intermediaries, such as SWIFT.
- Access to Financial Services
In a nation with high inflation or limited access to banking systems, USD-based stablecoins provide individuals with an avenue to safeguard their savings and access international financial markets and services. Just a digital wallet and an internet connection are needed.
- Decentralized Trading and Finance (DeFi)
Stablecoins play a central role in the DeFi ecosystem. That’s what serves as the primary medium of exchange, collateral for lending and borrowing, and a liquid base asset that you can trade on cryptocurrency exchanges.
- Programmable Money
Stablecoins run on blockchains. So, they can be incorporated into smart contracts to execute more intricate financial tasks, including escrow services, conditional payments, and automatic royalty payments.
Final Words
Still, there’s much more to know about stablecoins. If you want to gain insights into what differentiates stablecoins from other cryptocurrencies, what their real-world use cases are, and more, visit SoFi – a top-notch platform that will guide you in detail…
