Stablecoins, Explained

Introduction

The appearance of  blockchains and cryptocurrencies brought a hundred new concepts to our life. Some of them are easy to understand and some of them require a lot of interest and time to explore. 

As we all know cryptocurrencies are made to take the place of our regular cash, but explaining a new value for whole humanity is harder than building some new currency with old values. You may think that this sounds just like nonsense, but this is just the method that stablecoins are operating. These are new currencies that have the cost of the old and well-known currency. 

In this article, we are going to define what is a stablecoin, how does it work and why developers and blockchain experts thought that we need them.

What is a stablecoin?

A stablecoin is a relatively new kind of cryptocurrency, that has a value which is connected to another currency. 

Value of a stablecoin can be joined to everyday and common currencies like Euro or USD, they also can be attached to other cryptocurrencies, to some precious metals and so on. But the most popular version of stablecoins are those who are bound to fiat currencies and in most cases, this currency is the USD. This means that a unit of stablecoin which is attached to a USD equals $1.

You may ask why do I need a stablecoin if I can simply use a USD? The major reason is that stablecoins are cryptocurrencies and they operate on blockchains, so holding a stablecoin allows you to use the opportunities of this technology. 

Blockchain developers and experts explain the creation of stablecoins as a building of a coin that will not face the inherent unpredictability of other cryptocurrencies. Experts believe that unlike Bitcoin, which can gain value and lose it just in hours these coins are going to always keep their value.

Types of stablecoins

Stablecoins differ by the type of algorithms they’re working on. Here you can see 4 kinds of stablecoins.

1. Stablecoin baked from a fiat currency

This is kind of stablecoins is the first by popularity. Simply put, they are just a digital form of a fiat currency. The currency, which from the stablecoin was baked, and the stablecoin itself are supposed to always have the same ratio 1:1. This ratio is the main thing that makes stablecoin be actually stable.

The strangest thing in this kind of coins is that they’re operating on blockchain and are considered to be decentralized, but as they’re baked from a regular money and for making this baking real they are working with banks this brings a little bit of centralization to the system as the banks are always taking fiat currencies under their control.

These stablecoins have two main advantages: their operating system is easy to get and they are as stable as they can be.

2. Stablecoin backed up from commodities

These stablecoins are created from various precious metals, gas, etc. Your product can be placed in the market with a fungible asset or you can simply trade a product for hard cash.

In general, the commodity which is mostly used to bake a stablecoin is the gold. As this expensive and valuable metal always has a demand in markets, a stablecoin baked from it is supposed to be maximumly tradable. 

Stablecoins baked from commodities will have a value equal to some portion of that current commodity. For instance, one gold-baked stablecoin will have a value equal to one gramme of gold. 

But despite the high merchantability of these type, it’s not as popular as fiat currency baked ones.

3. Stablecoin baked from cryptocurrency

In most cases to bake a stablecoin from a cryptocurrency the most popular cryptocurrencies, like Ethereum or Bitcoin, are used. More often these stablecoins are baked from a mix of various stablecoins. This is done to avoid the unpredictability of a coin.

When the coin is baked from a mixture of cryptocurrencies, other cryptocurrencies compensate if one crypto’s price falls.

As we all understand that cryptocurrencies may have various values in different times it’s highly risky to invest in them, so this sort of stablecoins allow us to be cryptocurrencies investors but not lose our money simultaneously.

4. Non-collateralized stablecoin

This is a little unconventional type of stablecoin. The unique feature of them is that they don’t use any asset to be baked from, they just operate on a special algorithm that adds crypto and makes a rate more stable.

If the demand of the coin gets increased the algorithm mines new coins to bring balance to the system again. However, these coins have an indicative cost and it is $1, just like if they were baked from a USD.

Stablecoins and decentralization

Actually, if you understood the system of stablecoins you got that their nature is centralized. Yes, they just work against the “rules” of blockchains which are trying to be as decentralized as their system lets them be. But this is all about coins that are baked from fiat money. Operating with fiat money always requires some third-party, which can take control of everything. So when you, for instance, bake stablecoin from USD you directly link your blockchain to US banking system. And this is just out of the concept Nakamoto wanted to implement with the creation of Bitcoin’s blockchain.