Stablecoins and Types of Stablecoins? Read a short and Interesting note on this topic
The current market crash has shown cryptocurrency’s volatility, reducing mainstream participation in trading while limiting its use for buying and selling services and items.
Leveraging stablecoins has been a more favorable option for investors and regulators, increasing the demand for complete information on these unique digital coins.
What are Stablecoins?
What is Stablecoin, you may wonder? Stablecoins are less volatile versions of cryptocurrencies. Their value is tied against a stable, less volatile asset, including fiat currencies and precious metals. Furthermore, an algorithm is in charge of their regulation.
Why Do We Need Stablecoins in the First Place?
Cryptocurrencies introduced utterly new financial instruments. Big names such as Bitcoin and Ethereum can be highly volatile. Therefore, the need for stability rose. Stablecoins are a more reliable way of keeping your digital funds stable when the crypto market faces a downfall.
The different types of stablecoins have shown that stability can be integrated directly into a crypto asset. Moreover, consumers using cryptos to buy and sell goods and services not backed by currency may experience a significant price change after or during the transaction.
By using stablecoins, consumers won’t have to change their cryptos to fiat and won’t be subjected to such huge fees or exchange rates. So, stablecoins offer speedy transactions which are not time-consuming.
Types of Stablecoins
You can recognize the type of stablecoin by observing the collateral structure or asset backing them. The four major types of stablecoin structures are:
1. Commodity-Backed Stablecoins
Numerous types of interchangeable or hard assets back these commodity-backed coins. These include precious metals. Gold is the infamous commodity used as collateral for these stablecoins.
The other commodity types include real estate, precious metals other than gold, and oil. Commodities offer better chances of value appreciation over time. As a result, investors prefer the better incentives offered by holding and using commodity-backed stablecoins.
2. Fiat-Backed Stablecoins
Stablecoins tied to fiat currencies have a reserve of that currency as security or assurance. Typically, many fiat-backed currencies use dollar reserves as collateral. Remember, these types of stablecoins have a 1:1 backing ratio.
It simply means that a stablecoin has a 1-to-1 ratio: one unit of currency equals one coin. Users can redeem their coins as the fiat-backed entity managing the stablecoin takes the desired required fiat currency from its reserve and transfer the amount to the user’s bank account.
3. Cryptocurrency Backed Stablecoins
Cryptos can back stablecoins. The crypto coin will establish an overpriced stance to counteract the relatively higher volatility. In simpler words, the stablecoin will issue a relatively lower circulation supply compared to the reserve.
4. Algorithm-Backed Stablecoins
Some stablecoins are backed by a process or an algo instead of an asset. These stablecoins follow an algorithm that controls their supply, an approach known as seignorage sarees. Non-collateralized stablecoins can offer stability according to the market’s supply and demand.
Stablecoins are an essential way of investment in today’s era. They provide a stability that other highly volatile cryptos don’t. Studying and gaining knowledge about them is important if you’re looking forward to investing in them.