Stablecoins explained: how they work and how they affect the lives of ordinary people | Author: Ata Tekeli | Capital | July 2021
The most commonly used type of cryptocurrency.
Since the invention of stablecoins, cryptocurrencies have received considerable attention and alternative liquidity as well as more investment opportunities. In this section, we will explore what stablecoins are and how they affect the lives of ordinary people.
What is a stable currency?
Stablecoins are cryptocurrencies linked to specific assets. In other words, stablecoins can only have the market value of their asset class. They are divided into four categories: legal-based, commodity-based, crypto-based and unsecured stablecoins.
Why are there stable coins?
The emergence of stablecoins is because the crypto market is too volatile. Therefore, it is difficult for investors to provide liquidity in their own currencies. In order to solve this problem, various types of stablecoins have been launched on the market.
What are the characteristics of stablecoins?
Their value is tied to specific assets. Therefore, compared with the encrypted market, its value is relatively safe. Secondly, stablecoins provide most of the liquidity for the crypto market. Therefore, they have prospered the decentralized financial market through their own activities.
How does stablecoin work?
Since stablecoins are usually linked to certain assets, their supply and demand will vary according to the market value of their underlying assets. If their prices are lower than their market assets, they will reduce the supply so that their value is equal to their underlying assets. But if their value is higher than the underlying asset, they will increase the supply until their value equals their underlying asset.
A stable currency backed by fiat currency is a cryptocurrency backed by fiat currency. Because they provide custodial services to maintain prices, and they are usually audited. Tether (USDT), U.S. dollar coins (USDC) and Paxos Standard (PAX) are some examples of stablecoins supported by fiat currencies.
Commodity-backed stablecoins are cryptocurrencies backed by their underlying commodities. These include gold-backed stablecoins, oil-backed stablecoins, and timber-backed stablecoins. Their value depends entirely on the market value of their respective commodities. Like legally-backed stablecoins, commodity-backed stablecoins are also subject to audit and compliance checks. For example, Tether Gold (XAUT) and Paxos Gold (PAXG) can be used as examples of commodity-backed stablecoins.
Crypto-backed stablecoins are cryptocurrencies backed by various cryptocurrencies, and these types of cryptocurrencies are over-collateralized to maintain stability. Although they are not just cryptocurrencies, their value imitates their respective cryptocurrencies. DAI (DAI), Wrapped Bitcoin (WBTC), Wrapped Ethereum (WETH) and Wrapped Binance Coin (WBNB) can be shown as examples.
Unsecured stablecoins actually do not have any assets to support their respective stablecoins. Instead, their supply and demand are determined by algorithms. These algorithms work like a central bank to stabilize stablecoin prices. Kava’s USDX and Terra’s UST can be used as examples of unsecured stablecoins.
How do stablecoins affect our lives?
First, stablecoins are the main source of liquidity for cryptocurrency exchanges and decentralized finance (DeFi) protocols. Therefore, most of the financial activities related to cryptocurrency are carried out on stablecoins for various cryptocurrency transactions. Therefore, it provides more liquidity for exchanges and DeFi agreements and allows alternative financial agreements to flourish. As the use of cryptocurrencies and DeFi protocols increases at a faster rate, the use of stablecoins and DeFi protocols will increase at a faster rate, and they can help the financial ecosystem.