What Are The Different Types Of Stablecoins?

The term “stablecoin” refers to a category of digital currencies that are intended to keep their value stable by tying it to the value of another item. These assets may take the form of conventional currencies, commodities, or other vehicle types for financial transactions. In this article, we’ll dwell on what stablecoins are and what are the different types of stablecoins. Take a look.

What Are Stablecoins?

To provide a more steady alternative to the huge price volatility that are observed in major cryptocurrencies like Bitcoin (BTC), stablecoins were developed with the primary intention of providing a more stable alternative. These kinds of volatility frequently render these digital currencies unsuitable for use in day-to-day transactions.

The goal of stablecoins is to create price stability by tying their value to external benchmarks, such as the United States dollar, gold, or a variety of financial assets. Through the implementation of this strategy, the volatility that is typically associated with well-known cryptocurrencies such as Bitcoin will be reduced, thereby making digital currencies more suitable for use in everyday transactions. Before explaining the types of stablecoins, let’s figure out how they work. 

How Do Stablecoins Work?

The US dollar or a real asset like gold play an integral part in how stablecoins work. These digital currencies are designed to maintain a constant value by tying to them as fiat currencies. This connection structure aids stablecoins in mitigating the price volatility that many cryptocurrencies experience. For example, when a stablecoin is anchored to the US dollar, it means that there is a dollar in reserve for every stablecoin issued, keeping the digital currency’s value stable—hence the title “stablecoin.”

The assets that support the stablecoin are often stored in separate accounts controlled by regulated institutions. To promote transparency and confidence, these accounts are audited on a regular basis by third-party agencies. These audits confirm that there are sufficient reserves to support the issued stablecoins, hence ensuring their value.

Stablecoins use blockchain technology to provide fast, safe, and cost-effective transactions. They are internationally available to anybody with internet access, establishing themselves as a global digital currency. Stablecoins are also customisable, allowing them to be integrated with smart contracts and other blockchain-based apps to provide a variety of functions. 

Furthermore, all the types of stablecoin mitigate the cryptocurrency market’s volatility by offering a consistent value reserve. This enables individuals to save, swap, and transact with digital currencies without fear of sudden price changes. The combination of this stability and cryptocurrency’s intrinsic benefits makes stablecoins an important asset in the future of digital finance.

Different Types of Stablecoins

Algorithmic Stablecoins

Setting itself apart from asset-backed categories, the algorithmic stablecoin uses software algorithms to regulate its supply and thus its market value, without direct backing by other assets. Among different types of stablecoins, these ones aim to mirror the value of target assets through supply adjustments made by the underlying algorithms. The dramatic story of TerraUSD illustrates both the innovative potential and the risks of this approach, as its failure highlighted the vulnerabilities of relying solely on algorithmic mechanisms for stability, underscoring the precarious balance these coins must maintain between innovation and security.

Cryptocurrency-Secured Stablecoins

Cryptocurrency-secured stablecoins, paradoxically backed by the highly volatile assets they aim to stabilize against, operate on a principle diverging from the one-to-one pegging. To account for their underlying assets’ volatility, these stablecoins are typically over-collateralized. MakerDAO’s Dai (DAI) serves as a prime example, allowing users to deposit various cryptocurrencies as collateral on its platform, demanding a higher value in deposit than the DAI borrowed to safeguard against market fluctuations. Wrapped Bitcoin (WBTC) further illustrates this category, maintaining Bitcoin reserves as backing for tokens issued on Ethereum, using Bitcoin itself as collateral.

Commodity-Backed Stablecoins

These stablecoins offer digital equivalents to tangible assets like gold, silver, or oil, making investments in physical commodities accessible without the need for direct possession. This approach appeals to those seeking investment in precious materials without the logistical challenges of physical ownership. Gold-backed tokens, such as Paxos Gold (PAXG) and Tether Gold (XAUt), are popular, each unit representing a troy ounce of gold, thus marrying the digital convenience of cryptocurrencies with the intrinsic value of gold.

Fiat-Linked Stablecoins

Unlike traditional currencies, which were once backed by tangible assets like gold, modern fiat currencies, such as the U.S. dollar, derive their value from governmental decree and the dynamics of supply and demand. In this context, fiat-linked stablecoins emerge, anchored not by physical commodities but by such fiat currencies, typically in a one-to-one ratio. For instance, USD Coin (USDC) mirrors the U.S. dollar, with each USDC representing an equivalent dollar held in reserve. This structure aims for stability, albeit it introduces a level of centralization, as the maintaining of the peg requires oversight by centralized entities, necessitating trust in these organizations by the users.

Why Are Stablecoins Important to Cryptocurrency?

It’s widely recognised that the value of the currency fluctuates in numerous unpredictable ways, largely influenced by economic strength, thus posing significant risks to personal finances. Typically, individuals invest in precious metals, high-value assets, or prime real estate to safeguard their wealth. 

With the advent of cryptocurrencies, a new class of financial assets was introduced. Digital currencies like Ethereum and Bitcoin introduced a level of volatility unseen in traditional financial instruments, leading to the need for mechanisms to enhance stability. This need sparked a surge in interest in types of stable coins, particularly notable since July 2017. Stablecoins have become the most dependable method for protecting investments against the extreme price fluctuations of cryptocurrencies.

As with any nascent asset class, cryptocurrencies are affected by market dynamics. Various crypto initiatives are now exploring strategies to mitigate risk and encourage broader participation in the cryptocurrency ecosystem. The advent of different stablecoin models has illustrated how stability can be incorporated directly into digital assets, offering a way to combine the innovative potential of cryptocurrencies with the security of stable values.

Are Stablecoins a Good Investment?

Stablecoins do offer intriguing investment avenues, from generating passive income to providing tax advantages.

Generating Passive Income

Investors can tap into passive income with stablecoins through staking on numerous platforms, such as USDT and USDC. Staking entails purchasing and holding stablecoins for a certain period, yielding fixed interest afterwards. Interest rates offered by exchanges and investment platforms range from 3% to 20%, depending on the amount staked and the duration. For example, locking in $40,000 in USDT might secure a 14% interest rate for a minimum one-month term. While smaller amounts can also earn interest, returns are proportionately less. Platforms like Crypto.com offer up to 8.5% interest on USDC staking, making it essential to scout for the best rates and a trustworthy staking provider.

Preserving Investment Value

As stablecoins are linked to stable assets, they serve as a reliable store of value amidst market downturns. Shifting a portion of cryptocurrency holdings into stablecoins can safeguard against losses during volatility. In times of economic uncertainty, when investors gravitate towards gold and similar stable assets, the value of gold-backed stablecoins could rise in concert with the underlying asset. Additionally, stablecoins offer a way to avoid converting digital assets directly into fiat, potentially offering tax benefits. Their high liquidity means stablecoins can be easily converted to cash on most crypto exchanges.

The Most Popular Stablecoins

A lot of crypto exchanges provide an overview of the most popular stablecoins like USDT or BUSD, but we’d like to add 5 more as good as these. 

DAI

Dai (DAI), an Ethereum blockchain-based stablecoin, seeks to maintain parity with the U.S. dollar through algorithmic methods and is supported by digital assets on the decentralized MakerDAO platform, rather than traditional bank-held dollars, enabling users to lend and borrow crypto, with the caveat that upgrades or shutdowns may necessitate converting Dai back to Ethereum via Maker.

Neutrino USD (USDN)

USDN, an algorithmic stablecoin tied to the US dollar, relies on the WAVES token for backing and utilizes smart contracts for all its transactions.

FRAX

Frax (FRAX) employs a unique “fractional-algorithmic” approach, balancing between collateral backing and algorithmic stabilization to maintain its peg to the U.S. dollar, alongside offering FPI, indexed to the U.S. Consumer Price Index, and frxETH, aligned with the value of Ether (ETH), as it strives to create a scalable, decentralized, and algorithmic financial ecosystem as an alternative to fixed-supply cryptocurrencies such as Bitcoin.

PAX DOLLAR

Pax Dollar (USDP) is touted as the top regulated stablecoin globally, overseen by the New York State Department of Financial Services, with its reserves maintained in cash and similar liquid assets, ensuring that customer funds are securely held and always accessible for withdrawal.

Fei USD (FEI)

FEI, an algorithmic stablecoin crafted for the DeFi sector, launched in December 2020 and quickly captured the attention of the cryptocurrency world, resulting in a $19 million venture capital infusion by early March 2021.

The Future of Stablecoins 

The appeal of stablecoins has surged recently, and they are poised to become increasingly central within the crypto landscape. Offering a steadier alternative amidst the fluctuations of conventional cryptocurrencies, stablecoins are attracting those interested in investing or utilizing digital currencies for everyday transactions.

Their accessibility is expanding, with leading payment networks like PayPal and Visa now incorporating certain stablecoins for payments, marking a pivotal move toward broader stablecoin integration.

Moreover, stablecoins streamline international payments. Unlike the traditional banking sector, where international transfers may linger for days with significant costs, stablecoin transactions are swift and cost-effective, presenting a lucrative choice for businesses and individuals alike.

FAQ

How to Use Stablecoins?

Stablecoins serve as both a secure store of value and an efficient means for international transactions, offering unique advantages such as simpler cross-border fund transfers, along with opportunities for earning interest through lending and staking, all while being spendable worldwide directly from digital wallets.

Where Can I Buy and Exchange the Stablecoin?

You can exchange stablecoins at any crypto exchange. Although, we highly recommend checking the fees and rates used on the platform. At Godex.io, you get fixed rates, thus you can plan your activities. 

What are the Risks With Stablecoins?

Despite being lower-risk compared to other cryptocurrencies, stablecoins still carry inherent crypto challenges and specific risks unique to them, such as technological, centralization, counterparty, market/economic, systemic, and regulatory uncertainties.

Disclaimer: Please keep in mind that the content of this article is not financial or investing advice. The information provided is the author’s opinion only and should not be considered as direct recommendations for trading or investment. Any article reader or website visitor should consider multiple viewpoints and become familiar with all local regulations before cryptocurrency investment. We do not make any warranties about reliability and accuracy of this information.