💸What are Stablecoins

Beginner's Guide (Oleg Polunin, author)

Stablecoins are digital assets tied to the value of fiat currencies or other assets with a stable exchange rate.
For example, you can buy tokens tied to the dollar, euro, yen, as well as gold and oil.
Stablecoins allow to fix profits and losses and transfer assets at a stable price in blockchain networks.

Bitcoin (BTC), ether (ETH), and other altcoins have been volatile since their inception.
This provides opportunities for speculation, but also creates difficulties.
Volatility complicates the use of cryptocurrencies for everyday payments. For example, a coffee shop may sell coffee for $5 in BTC, but the BTC received the next day may depreciate by 10%, making business planning difficult.

Previously, crypto investors and traders could not lock in profits or avoid volatility without converting cryptocurrency back into fiat.
Stablecoins have solved this problem by allowing volatility control through coins like USDT. ?

How do stablecoins work?

To create a coin tracking the price of another asset, a pegging mechanism is needed.
Usually, a different asset is used as collateral.
Methods may vary, and none of them guarantees absolute stability.

• Fiat-backed stablecoins.
They keep fiat currency in reserves. For example, each USDT is backed by $1.
Users can convert fiat to stablecoin and vice versa at a fixed rate.

• Cryptocurrency-backed stablecoins.
They use cryptocurrency as collateral. Due to the volatility of the crypto market, excess reserves are used to protect against price fluctuations. They use smart contracts to create and burn coins, which provides additional reliability. An example is DAI, which requires collateral 1.5 times greater than its value. If the price of the stablecoin falls below $1, the coin supply shrinks, and the price stabilizes.

• Algorithmic stablecoins.
They don't have reserves. Their supply is regulated by algorithms and smart contracts. When the price falls below the cost of fiat currency, the supply decreases, and when it exceeds, it increases. This approach is more difficult to manage and is less common.

Advantages of stablecoins:
• They are suitable for everyday payments due to their stability.
• Stablecoins are created on the blockchain, allowing them to be quickly and securely transferred worldwide.
• They help traders and investors hedge their portfolios, reducing overall risk and providing opportunities for advantageous purchases in the future.

Disadvantages of stablecoins:
• Binding is not always guaranteed, and some projects may simply depreciate.
Not all stablecoins publish transparent audits.
• Fiat-backed stablecoins are often more centralized and subject to financial regulation.
• Cryptocurrency-backed and algorithmic stablecoins rely on their communities, requiring user participation in project management.

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