Cryptocurrencies are highly volatile. It can go up and down significantly, almost without warning. This could be a reasonable stablecoin created as it does not change its value with respect to the market and is anchored to the corresponding asset or algorithm. Stablecoins can be thought of as a safety net in highly volatile markets.
Stablecoins are classified as fiat collateral, which are coins backed by currencies such as US dollars and euros, based on the asset they are pegged to. It is encrypted, backed by cryptocurrencies such as BTC, ADA, and backed by algorithms that use computer algorithmic code to fix its value.
practicality of stablecoin Offering inherent market capitalization and ease of movement of funds, regulators are now keeping a close eye on stablecoins. Many countries are in the process of introducing Central Bank Digital Currencies (CBDC).
Stablecoins offer very interesting use cases compared to cryptocurrencies and tokens. Let’s say Mr. X buys collectibles from Mr. Y and pays the amount in Bitcoins. BTC was at $18,500 at the time of the transaction, and by the time it was delivered, the price had dropped to $18,250. This volatility, in turn, can be harmful.
Stablecoins therefore offer a good alternative, USDT is pegged to the USD and its price fluctuates between 0.99 and $1.1. This allows stablecoins to have better reach than all other coins and tokens.
A pegging mechanism is required to create a coin that can track the price and value of different commodities. And there are many ways to do it. Some use collateral, some use algorithms, and some use burning and minting to lock in their value.
Stablecoin backed by fiat currency
Fiat-backed stablecoins hold fiat currencies such as USD, GBP, and EUR as reserves. Users can exchange these types of stablecoins according to a fixed value. And if the value of fiat currency is based on decline, they manage it by getting more and removing some.
They function similarly to fiat-backed stablecoins, with the main difference being that they are cryptocurrency-backed and the same is held as collateral. Due to the high volatility, crypto-backed stablecoins are generally over-collateralized and reserves are measured against price movements.
They take a different approach by leaving fiat and cryptocurrencies out of the mix. Instead, it uses algorithms and smart contracts to manage supply. In this case, the algorithm burns old or new coins as per the requirement.