A stablecoin is a type of cryptocurrency whose value is tied to an asset such as the U.S. dollar or gold to maintain a stable price.
Stablecoins aim to provide an alternative to the high volatility of the most popular cryptocurrencies, including Bitcoin, which has made crypto investments less suitable for common transactions.
Types of Stablecoins
Stablecoins are typically pegged to a currency or a commodity like gold, and they use different mechanisms to maintain their price peg.
The two most common methods are to maintain a pool of reserve assets as collateral or use an algorithmic formula to control the supply of a coin.
Collateralized Stablecoins
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.
USD Coin (USDC) is a prime example of a collateralized stablecoin.
The most prominent and oldest stablecoin is Tether (USDT). USDT is currently the third biggest cryptocurrency, behind Bitcoin and Ethereum (ETH).
Algorithmic Stablecoins
Algorithmic stablecoins maintain their price peg via algorithms that control the supply of the token. Algorithmic stablecoins typically rely on two tokens – one stablecoin and another cryptocurrency that backs the stablecoins – and so the algorithm (or the smart contact) regulates the relationship between the two.
TerraUSD (UST) was the biggest algorithmic stablecoin, reaching a market cap of more than $18.7 billion at its peak before it began to plummet sharply after it slipped below its peg.
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Kapil Rajyaguru
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