The biggest example in this category is the DAI (DAI) algorithmic stablecoin, which is pegged to the U.S. dollar but is backed by Ethereum and other cryptocurrencies. Collateralized stablecoins maintain a pool of collateral to support the coin’s value. Whenever the holder of a stablecoin wishes to cash out their tokens, an equal amount of the collateralizing assets is taken from the reserves. Fiat currencies, such as the U.S. dollar or the British pound, don’t see this level of price volatility. So another way to think about stablecoins is as a tokenized version of a fiat currency. In theory, a U.S. dollar-based stablecoin is a token that will reside on a blockchain and always trade for one dollar.
Stablecoins continue to come under scrutiny by regulators, given the rapid growth of the $162 billion market and its potential to affect the broader financial system. In October 2021, the International Organization of Securities Commissions (IOSCO) said stablecoins should be regulated as financial market infrastructure alongside payment systems and clearinghouses. Its proposed rules focus on stablecoins that are deemed systemically important by regulators, those with the potential to disrupt payment and settlement transactions. If you look closely, less than 4 percent was actual cash, while most is held in short-term corporate debt. If markets drop, those assets (and the other non-cash assets) could quickly decline in value, making the Tether coin less than fully reserved exactly when it may most need to be.
USD Coin
In addition to individual and business payments, stablecoins can be used for trading, borrowing and lending, earning yield, as alternatives to banking, for sending remittances, as stores of value, and more. Currently, stablecoin regulations are still up for discussion in most jurisdictions. Legislation to regulate stablecoin issuers is proposed but yet to be enacted. Such fluctuations, or so-called ‘short-term volatility’, make cryptocurrencies unfavourable for everyday use by the general public. On the other hand, decentralized stablecoins have revenue modes that vary from protocol to protocol. Examples of fiat-backed stablecoins include Tether (USDT) and USD Coin (USDC).
Of these, gold is generally the most popular commodity used as collateral for commodity-backed stablecoins. Because their goal is to track an asset, stablecoins are often backed by the specific assets they’re pegged to. For example, the organization issuing a stablecoin typically sets up a reserve at a financial institution that holds the underlying asset. So, a stablecoin could hold $100 million in reserve and issue 100 million coins with a fixed value of $1 per coin. If a stablecoin’s owner wants to cash out the coin, the real money can ultimately be taken from the reserve. A stablecoin is a cryptocurrency whose value is “pegged” (meaning tied) to another asset—often a traditional fiat currency like the US dollar.
Frax aims to provide “highly scalable, decentralized, algorithmic money” in place of fixed-supply digital assets like Bitcoin. Fiat-backed stablecoins use government-issued currency like the U.S. dollar as collateral. Users can convert from fiat into a stablecoin and vice versa at whatever the pegged rate is.
Crypto at Fidelity
However, its price then dramatically dropped three months later in May 2021 to approximately US$34,000. Get the full lowdown on stablecoins, what they are, how they work, where to buy them, and the most popular tokens. TerraUSD (UST) was the biggest algorithmic stablecoin, reaching a market cap of more than $18.7 billion at its peak on May 5 before it began to plummet sharply after it slipped below its peg. The graph below shows USDC’s collateral reserves as of August 2022—at $54 billion, the coin’s reserves are slightly greater than its liabilities of $53.8 billion.
- The stablecoin issuer ensures stability of their cryptocurrency by keeping fiat currency as collateral with a financial institution.
- In 2024, Senators Lummis and Kirsten Gillibrand introduced a bill to create a regulatory framework for stablecoins.
- Fiat-backed stablecoins use government-issued currency like the U.S. dollar as collateral.
- Adam Hayes, Ph.D., CFA, is a financial writer with 15+ years Wall Street experience as a derivatives trader.
- Instead of relying on a central issuer to store the reserve, crypto-backed stables use smart contracts to secure assets as collateral.
- Crypto’s total market capitalization can rise and fall by billions of dollars a day.
As the name suggests, crypto-collateralized stablecoins are backed by cryptocurrencies (usually ETH), rather than fiat currencies. Instead of relying on a central issuer to store the reserve, crypto-backed stables use smart contracts to secure assets as collateral. This means that for every $100 of DAI you wish to borrow, you must back it with $200 worth of ETH.
A common concern over stablecoins is whether they are secure and can be relied on as an alternative to fiat. Check the issuing entity, its history, and past projects in detail before purchasing its stablecoins. Second, if in doubt, users can move their funds into other stablecoins or even other cryptocurrencies. Algorithmic stablecoins largely depend on independent traders who are interested in profiting from an algorithm’s arbitrage opportunities to maintain the peg. In periods of uncertainty or crisis, the lack of demand for a digital asset can cause it to lose tremendous value in a short amount of time.
Currently, cryptocurrencies are volatile and can experience dramatic price fluctuations in a short period of time. Bitcoin, for example, can rise or drop by double-digit percentages in chapter 6 how to run a data visualization project a reader on data visualization just a few hours. Stablecoin advocates believe these cryptocurrencies are critical for bridging “real-world” assets like fiat currencies with digital assets on the blockchain.
Why Are Stablecoins So Important?
Remember, a stablecoin’s primary purpose is to provide value stability where other cryptocurrencies may not be able to. These benefits make stablecoins more competitive than other cryptocurrencies, as they relieve a number of consumer and business pain points. BTC and other cryptocurrencies are currently not able to offer the same level of stability and scalability for real-time transactions as compared to stablecoins. The value of stablecoins of this type is based on the value of the backing currency, which is held by a third party–regulated financial entity. Fiat-backed stablecoins can be traded on exchanges and are redeemable from the issuer.
As of writing this article, the stablecoin market is worth nearly 140 billion U.S. dollars. The stablecoin with the highest market capitalization value is Tether, which is pegged to the U.S. dollar as its fiat-backed currency. Algorithmic stablecoins use algorithms and smart contracts to manage the supply of the tokens issued. The system will reduce the token supply if the price falls below whatever fiat currency it tracks through methods like burning or buybacks. If the price surpasses the value of the fiat currency, new tokens will be put into circulation to reduce the stablecoin’s value.
This kind of crypto coin tracks the underlying asset, making its value stable over time, at least relative to the currency it’s pegged to. In effect, it’s as if the underlying asset has gone electronic, for example, like a digital dollar. Stablecoins aim to solve this uncertainty, attempting to combine the stability of cash with the benefits of crypto technology. On one hand, they operate on blockchains, which supporters believe provide greater security, transparency, cost efficiency, and speed. On the other, they try to reflect the value of real-world assets like the US dollar. Proponents argue this combination makes stablecoins particularly useful as they act as a kind of bridge between traditional assets and the crypto economy.
Reserve-backed stablecoins
Crypto-backed stablecoins are cryptocurrencies that use one or more cryptocurrencies as collateral to provide their stability. These stablecoins use a mix of smart contracts on find engineering mentors and mentoring the blockchain to lock in cryptocurrency reserves instead of relying on a central financial institution to hold reserves like fiat-backed cryptocurrencies. That said, some have called for more regulation around stablecoins given their rapid and popular growth.
Others are skeptical, noting that they’ve played major roles in the collapse of several cryptocurrencies and crypto institutions. Fiat currencies are the currencies you and I use every day to buy groceries and services such as the U.S. dollar, the British pound or the Euro (depending on where you are in the world). Fiat currencies offer a stable and largely predictable amount of value, making them suitable for both short and long term financial transactions. Stablecoins attempt to bridge the gap between these stable options and cryptocurrencies, which have shown volatility but offer greater utility benefits. Stablecoins peg their value to other currencies, collateral or algorithms in order to offer more stability than other cryptocurrencies and to behave more predictably, like fiat currency. Unless a stablecoin commits to holding 100 percent (or more) of its reserves in cash, there’s no guarantee that the cash will be there to redeem coins.
It’s important to note the risk of depegging may be higher for algorithmic stablecoins than for other types that have sufficient and transparent reserves. During the same time, the broader crypto market was experiencing a sell-off. Both these factors occurring simultaneously sent top crypto exchange fees to know about the stablecoin spiraling, making it essentially worthless overnight. Unlike the types above, algorithmic stablecoins are typically uncollateralized.
Though Bitcoin remains the most popular cryptocurrency, it tends to suffer from high volatility in its price, or exchange rate. For instance, Bitcoin’s price rose from just under $5,000 in March 2020 to over $63,000 in April 2021, only to plunge almost 50% over the next two months. Intraday swings also can be wild; the cryptocurrency often moves more than 10% in the span of a few hours. PayPal USD (PYUSD), launched by payments platform PayPal, is a stablecoin pegged to the U.S. dollar. The stablecoin is backed by secure dollar deposits, U.S. treasuries and cash equivalents to keep it matched to a $1 value. PayPal USD can be bought, sold, sent, received and converted to other currencies through PayPal, and can also be used as a payment method when checking out in online stores using PayPal.