Today we will talk about stablecoins and their types. Let’s get started.
Why Stablecoins?
Why not ETH or BTC?
We have cryptocurrencies on the Ethereum, Bitcoin, Solana, etc. blockchain, so why do we need a stablecoin? Because cryptocurrencies are volatile, we can not use them for daily tasks and payments like buying bread.
Let’s imagine for a second, we are using cryptos for buying bread. Say the price of bread is $12 and the current price of ETH in your wallet is $12. Great. But mum called and after 5 minutes we were back, but the cost of ETH went down, now our wallet has only $8 worthof ETH, what are we gonna do now?
‘cause they’re volatile
This happened because cryptos are very volatile i.e. their price fluctuates in a short period, and inconvenient for such above tasks. Say you took loan, and have to give collateral, you can not give cryptos like ETH or BTC as their prices are not fixed, they vary a lot.
Our saviour: STABLECOINS!
What are stablecoins?
defining it
Stablecoins are also cryptocurrencies but pegged to a more stable asset like fiat currency, gold/precious metals, etc. Thus they are less volatile than cryptocurrencies like ETH, BTC, SOL, etc. So they exist on blockchain while maintaining stable value.
what’s so good about it?
cryptocurrency is volatile, if a market crash happens, investors will want to preserve their money and instantly convert that crashing volatile token to a stablecoin say USDC (pegged 1:1 to US dollars). So they won’t have to move out of the web3 ecosystem but save value. Why not convert it to fiat, well then we are back at square one, under those centralized entities, unfair policies, slow transactions, and much more.
Types of Stablecoin
We will discuss the broad types:
fiat-backed
backed by government currency like US dollars $, euro €, etc.
managed by a central authority
for every stablecoin in circulation, there is a corresponding dollar in the bank’s reserve.
eg. Tether, USDC, PYUSD, GUSD, etc
crypto-backed
backed by a token or multiple tokens.
users deposit crypto (ETH into the Aave pool) and stablecoins (GHO) are minted against it.
overcollaterized as crypto are volatile, to de-risk volatility of assets, more crypto is deposited as compared to stablecoins minted. Total circulating stablecoins will be less than total collateral.
eg. GHO, LUSD, SUSD, etc
algorithmic
backed by nothing
stablecoin’s price is maintained by an algorithm that adjusts according to market conditions.
but sensitive to market fluctuations, if a sudden panic occurs (Terra/Luna Crash), and people start losing faith in that stablecoin, its price can go down.
eg. UST on Terra/Luna, fei, early frax, etc.