What is stablecoin and what is its relationship with cryptocurrencies

An increasingly common word among cryptocurrency news is stablecoin. The denomination refers to cryptocurrencies whose exchange value is related to the value of a financial asset, such as gold or dollar.

The expectation is that stablecoins will be more stable in their market value. However, recently, stablecoin Terra lost its parity relationship with the dollar and its value dropped to US$0.31, according to the Investopedia. Terra is an example of a currency that surprised those who were betting on the stability of this type of currency.

Stablecoins are mostly used as an investment or financial instrument. They are an alternative to the high volatility of more popular cryptocurrencies like Bitcoin. They have been used more for negotiations of bigger amounts. Stables can hit the market with a reserve value to insure their losses. They can also be controlled by mathematical, algorithmic rules that regulate their supply and demand.

The advantage of stablecoins is that they are part of a decentralized digital financial system, not relying on banks. There are three types of stablecoins depending on what they are used to stabilize their value.

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1) Stablecoin related to traditional currencies

Stable cryptocurrencies related to traditional currencies such as the dollar usually have a cash reserve to ensure their stability. Other forms of collateral are gold or silver, as well as commodities such as oil. Most are linked to the US dollar.

Reserves are held in independent custody and regularly audited. Tether (USDT) and TrueUSD (TUSD) are stable currencies that reserve the dollar and maintain parity. As of May 2022, Tether (USDT) is the most traded cryptocurrency when market capital is taken into account, with a value in excess of $83 billion.

stablecoin cryptocurrency wallet

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2) Cryptocurrency related stablecoin

A stablecoin related to cryptocurrencies has the reserve in crypto. This means that the currency can be prone to high volatility. Often these stablecoins have extra reserve, a higher value of cryptocurrencies than their market capital so they have greater collateral.

One example is the stable coin DAI, created by MakerDAO. Its proposal is to be related to the dollar and also to Ethereum (ETH) and other cryptocurrencies. Your reservation has 150% of the DAI value that is in circulation.

Stablecoin cryptocurrencies

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3) Stablecoin related algorithms

Stable coins related to algorithms may not have assets in reserve. Its main feature is to have a strategy of maintaining value by controlling supply and demand. This control is accomplished by an algorithm, essentially computer programs that execute mathematical formulas.

This type of stablecoin is more akin to centralized governance, as in banks. However, unlike banks, there is no public monetary policy that ensures its stability.

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