What exactly is a Stablecoin?
Stablecoins are a type of cryptocurrency that are designed to have a stable value relative to another currency, commodity or asset. The value of a stablecoin is "pegged" to the value of the underlying asset, meaning that it is intended to maintain a stable value even as the market fluctuates. This makes stablecoins useful for transactions and as a store of value.
Two examples of stablecoins are USD Tether (USDT) and USD Coin (USDC), both of which are pegged to the value of the US dollar. This means that the value of each USDT or USDC token is intended to be equivalent to one US dollar. Other stablecoins are pegged to the value of other assets, such as gold. An example of this is Tether Gold (XAUT), which is pegged to the value of gold.
How is the value of the Stablecoin "Pegged"?
There are a variety of various methods through which stablecoins' values are pegged:
Fiat-collateralized: These stablecoins are backed by a national fiat currency that is utilised as an off-chain reserve asset to support the stablecoin's value. Reserve currencies such as the US dollar would be retained in proportion to the quantity of stablecoins in circulation. Typically, this reserve money would be held by third-party custodians and/or banks. To ensure that the stablecoin's value remains pegged to the underlying fiat currency, the centralised controling entity would issue new stablecoins or remove an amount in circulation.
Crypto-collateralised: These stablecoins function similarly to fiat-collateralized stablecoins, except instead of fiat money, cryptocurrencies are kept in reserve as collateral to ensure the stablecoin maintains its peg.
Asset/commodity collateralised: Similar to crypto-collateralised stablecoins, these stablecoins work by keeping a reserve of one or more commodities or assets such as gold in order for the stablecoin to maintain its peg to the asset / commodity or group of same.
Non-collateralised (Algorithmic) Stablecoins: These stablecoins are among the most complicated stablecoins and do not rely on a reserve asset or asset pool as collateral. They rely instead on centrally-developed algorithms to maintain their peg to the respective fiat currency, cryptocurrency, commodity, or asset. While these stablecoins eliminate the need for substantial underlying capital, they rely significantly on customer confidence and are more susceptible to abrupt devaluation or even collapse than other stablecoin types.
What use do Stablecoins serve?
In recent years, stablecoins have been viewed as an alternative to more traditional crypto assets such as Bitcoin and Ethereum, which are often linked with greater volatility rates. Stablecoins are now traded on a number of crypto exchanges and provide investors a quick and easy method to invest on platforms and exchanges without having to transfer their standard cryptocurrency holdings back into fiat currency.
Many regulators have expressed skepticism about stablecoins and their potential impact on financial stability. The EU's proposed Markets in Crypto Assets Regulation, for example, refers to stablecoins as "so-called stablecoins," indicating a lack of confidence in their stability. Some regulators have concerns that a widely adopted stablecoin could potentially replace fiat currencies as a means of payment and potentially undermine the role of central authorities in preserving financial stability and controlling the money supply of an economy.