Last Updated on December 12, 2024 by Olga
While cryptocurrencies are known for their significant price fluctuations, stablecoins offer a solution by mimicking the value of a fiat currency. This makes them an appealing option for those who seek the benefits of digital assets but without the risk of wild price swings. In this article, we’ll explore the different mechanisms behind stablecoins and examine their advantages and drawbacks.
And if you’re exploring the exciting world of cryptocurrency, make sure you don’t miss our in-depth expert articles on XDC wallets, Binance Coin wallets, and the Kaspa web wallet. Stay informed and ahead of the curve with the latest insights and tips!
Before Exploring How Stablecoins Work
When it comes to leveraging your cryptocurrency holdings, CoinRabbit offers a unique and innovative solution. Unlike traditional platforms that require you to sell your assets to unlock liquidity, CoinRabbit allows you to access funds through a flexible crypto loan service. This approach enables you to retain full ownership of your assets while still unlocking their potential. Whether you’re looking to diversify your portfolio or take advantage of new opportunities, CoinRabbit provides a secure and efficient way to maximize the value of your crypto holdings without giving them up.
How Do Stablecoins Work?
There are several types of stablecoins, each of which has a different peg of its units to fiat currency. Some of the more common types are listed below.
Fiat-backed Stablecoins
The most popular type of stablecoins is one that is directly pegged to fiat currency at a 1:1 ratio. We also call these fiat-backed stablecoins. The central authority issuer stores a certain amount in reserve currency and issues a proportional amount of tokens. So, price fluctuations are not considered.
For example, an issuer might have one million dollars and distribute one dollar for each of the million tokens. Thanks to this, users can exchange their cryptocurrencies for tokens at any time, the value of which is equivalent to the US dollar.
Crypto-backed Stablecoins
The crypto-backing of stablecoins mirrors their fiat counterparts, with the main difference being that the crypto assets are used as collateral. However, because the cryptocurrency is digital, only smart contracts handle the issue of units.
Crypto-backed stablecoins minimize the necessary trust, for this reason, it should be noted that their monetary policy is determined by the voters, by analogy with government structural elements. In this case, you cannot completely trust the issuer, but you believe that all network participants will always act in the interests of users.
To get this kind of stablecoins, users block the required cryptocurrency in a contract, which then issues a certain number of requested coins. In the future, to return the collateral, users send stablecoins to the same contract for reverse currency exchange (taking into account various commissions or interest rates).
The specific mechanisms of their work, which provide this very link to another asset, vary depending on the design of each of the systems. Suffice it to say that the combination of game theory and chain algorithms encourages participants to maintain a stable coin value.
Algorithmic Stablecoins
Algorithmic stablecoins are not pegged to fiat or cryptocurrency. Instead, price stability is achieved solely by algorithms and smart contracts that manage the delivery of the token issue. From a functional point of view, their monetary policy has similarities with the management of national currencies represented by central banks.
At its core, the algorithmic stablecoin system reduces the supply of tokens if the price falls below the value of the monitored fiat currency. If the price exceeds the required value of the pegged currency, then new tokens come into circulation to reduce the cost of the stablecoin. We advise keeping an eye on real-time data for stablecoins to stay informed about market fluctuations.
Pros and Cons of Stablecoins
The main advantage of stablecoins is the additional ability to fix balances and exchange digital currencies. Due to the high level of price volatility, cryptocurrencies have not been able to find their use in everyday life, for example, for making various payments. By providing a higher level of stability, such stable currencies act as a solution to this problem.
As a way to protect their capital from market volatility, stablecoins are becoming a feature in the integration of cryptocurrencies with traditional financial markets. Currently, the two markets exist as separate ecosystems with very little interaction. With the stable form available for digital currencies, cryptocurrencies will likely see a wider range of use cases in the loan and lending market, which to this day are dominated only by government-issued currencies – fiat currencies.
In addition to their usefulness for financial transactions, traders and investors can use stablecoins to hedge their portfolios. Allocating a certain percentage of your portfolio in stablecoins is an effective way to reduce your overall risk.
Despite their ability to support massive crypto adoption, stablecoins still have certain drawbacks. Fiat-backed options are a less decentralized solution than conventional cryptocurrencies, as there is still a need for a central institution to store ancillary assets. As for crypto-backed and unsecured stablecoins, users will need to trust the community (and source code) to guarantee the long-term performance of the system, but for now, these are still relatively new technologies, so they will take some time to mature.
Stablecoins: So What?
While stablecoins have some drawbacks, they are a critical component of the cryptocurrency market. Thanks to various mechanisms, this type of digital currency can remain more or less stable, with its own fixed price. This allows them to be reliably used not only as a medium of exchange but also as a way to fix their balance for traders and investors.
While stablecoins were originally developed as an effective risk management tool, their scope goes beyond trading. This type of digital currency is a powerful tool that can help strengthen the cryptocurrency ecosystem as a whole, as well as an alternative store of value in cases of high market volatility. Here in the CoinRabbit, we support two stablecoins: USDC and USDT. By the way, we have in-depth articles on USDT vs USDC, and how can you borrow and lend USDC. Be sure to check them out!
What is USDT?
USDT is a Tether, which is a cryptocurrency that is tied to a fiat currency for stability. It is released on the Bitcoin blockchain through Protocol Omni. Its value is the exchange rate is fixed or tethered, to the value of the US dollar.
The only reason why 1 USDT is worth $1 is that exchanges keep a reserve of USD to back every USDT in existence. USDT can be spent, traded, or transferred, like Bitcoins or any cryptocurrency. They can also be stored in specialized wallets that are Omni compatible.
What is USDС?
USD Coin (USDC) is a cryptocurrency called stablecoin. You can always exchange 1 USD Coin for 1 USD to make its value more stable. So, it is a digital stablecoin that is pegged to the United States dollar and runs on the Ethereum blockchain.
Unlike regular US dollars, USD Coin does not require a bank account. Moreover, you do not need to live in any particular country. Sending USD Coin worldwide can be done at a very low cost and in just a few minutes. USD Coins aren’t just being printed out of thin air. Every USDC token is backed with a single US dollar. The process of turning US dollars into USDC tokens is called tokenization.
Loan Advantages on CoinRabbit
CoinRabbit offers a fast and simple loan process, with just three easy steps to get the funds you need. Once you deposit your collateral — whether it’s BTC, ETH, BCH, or NANO — your loan will be sent to you within minutes. Why waste time on complicated procedures when you could be focusing on other important things?
We make the process seamless by eliminating the need for sign-ups, passwords, or lengthy paperwork. All you need is a wallet to receive your loan and a phone number to track it. It’s that simple.
We believe in flexibility and freedom. That’s why we don’t limit your crypto loans term — you can keep your funds with us for as little as a day, a week, or as long as a year, depending on your needs. When you’re ready to retrieve your collateral, simply repay the full loan amount. Once we receive your payment, we’ll return your collateral, no questions asked.
DISCLAIMER: The information provided in this article is for educational and informational purposes only and should not be construed as financial advice. Cryptocurrency investments carry a high level of risk, and it is essential to conduct thorough research and consult with a qualified financial advisor before making any investment decisions. The views and opinions expressed in this article are those of the author and do not necessarily reflect the official policy or position of any financial institution or organization. Always invest responsibly and consider your individual financial situation before making investment choices.
