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When it comes to cryptocurrencies, one cannot overlook their volatility. However, there is one type of cryptocurrency that is particularly designed to provide a stable price: stablecoins.
Stablecoins have become essential components in the crypto world, offering important functions for investors and speculators.
Stablecoins are digital currencies that are pegged to a "stable" reserve asset, such as the US dollar or gold. Stablecoins are intended to lessen volatility in comparison to unpegged cryptocurrencies.
The entire cryptocurrency market capitalization can fluctuate by billions of dollars a day. Fiat currencies, such as the US dollar or the British pound, do not experience this amount of price fluctuation. Another way to think of stablecoins is as a tokenized version of fiat money. In theory, a US dollar-based stablecoin is a token that will stay on a blockchain and always trade for a dollar.
Some events have highlighted that stablecoins can differ in their ability to maintain price stability. For example, the TerraUSD crash showed that even stablecoins may not always guarantee stable prices.
Stablecoins are classified into three types based on the mechanism used to keep their value stable.
The best known stablecoins are those used for trading on cryptocurrency exchanges. Tether (USDT) is the most popular stablecoin, with one of the top five highest market caps for cryptocurrencies.
Another is USD coin, or USDC, an open source project managed by a consortium called Centre, and binance USD, a stablecoin created by Binance, the world's largest cryptocurrency exchange.
On the other hand, DAI is a cryptocurrency built on the Ethereum blockchain and is governed and operated by MakerDAO, a decentralized autonomous organization (DAO). As one of the first examples of decentralized finance (DeFi) to gain widespread acceptance, DAI has established itself as a popular and viable option for those seeking a stable cryptocurrency.
Stablecoins are currently under heightened scrutiny from regulators due to their rapid growth and the potential for them to impact the wider financial system. In October 2021, the International Organization of Securities Commissions (IOSCO) recommended that stablecoins, like payment networks and clearinghouses, be regulated as financial market infrastructure. The proposed regulatory measures would mainly focus on stablecoins that are deemed to be of systemic importance by regulatory authorities.
Compared to cryptocurrencies that lack any underlying asset or backing, stablecoins are generally considered to be lower-risk coins. However, like other types of cryptocurrencies, stablecoins are not without risk. The reserves that back a stablecoin are a crucial component of the stablecoin ecosystem, serving as the last line of defense for the coin's value. Without adequate reserves, the issuer cannot guarantee the value of the stablecoin.
While the use of stablecoins may appear to be fully decentralized, the transactions actually involve multiple parties, including the bank that holds the reserves and the company that creates the stablecoin. In order to maintain the coin's value, these parties must take the right actions in terms of security, reserve adequacy, and other factors.
The main risk associated with stablecoins is the possibility that they are not fully backed by the reserve currencies they purport to be backed by. This can occur if the reserve is not adequately secured or if the reserve currency itself experiences significant fluctuations in value."
Each USDU coin is backed by the US dollar, positioned in custodian bank or by USDC coin (a cryptocurrency with a stable price), positioned in custodian escrow firm.
Fiat money is a government-issued currency that is not backed by a tangible commodity like gold or silver, but rather by the government that...
Tether allows customers to make transactions with traditional currencies on the blockchain, eliminating the volatility and complexity often associated with...