What Are Stablecoins and How Do They Work?

You can send a stablecoin to anyone globally who has a compatible crypto wallet (which can be created for free in seconds). Double-spending and false transactions are also almost impossible to run into. Commodity-backed stablecoins make precious metals and other commodities easy to carry and more divisible while maintaining the same value as their reserve.

what is a stablecoin in cryptocurrency

The value of stablecoins of this type is based on the value of the backing currency, which is held by a third-party–regulated financial entity. Fiat-backed stablecoins can be traded on exchanges and are redeemable from the issuer. The stability of the stablecoin is equivalent to the cost of maintaining the backing reserve and the cost of legal compliance, licenses, auditors, and the business infrastructure required by the regulator. Instead, its value was supposed to be maintained by a complex mechanism involving swapping TerraUSD coins with a free-floating cryptocurrency called Luna to control supply.

Why have stablecoins become so popular?

A stablecoin is one type of cryptocurrency that is designed to maintain a fixed value over time. The value of a stablecoin is typically pegged to a specific real currency, often the U.S. dollar. In this setup, one unit of the cryptocurrency typically equals one unit of the real currency. Unlike highly volatile cryptocurrencies such as Bitcoin, the price of stablecoins is not meant to fluctuate.

  • Over the past month, investors have seen around a 4% daily change in the value of BTC.
  • In other words, Tether is a stablecoin that is designed to provide stability to cryptocurrency trading.
  • BUSD is available on the Binance exchange, as well as other major exchanges, and can be used for trading, investing, and buying goods and services.
  • Other forms of collateral can include precious metals like gold or silver as well as commodities like crude oil, but most fiat-collateralized stablecoins have reserves of U.S. dollars.
  • The value of crypto assets can increase or decrease, and you could lose all or a substantial amount of your purchase price.

The largest stablecoin, Tether, has a market cap of around $80 billion, having surged from just $4.1 billion at the start of 2020. Stablecoins have a market cap of around $170 billion, making them a relatively small part of the overall cryptocurrency market, which is currently worth around $1.2 trillion, according to CoinMarketCap data. TrueUSD is built on the Ethereum Blockchain, https://www.xcritical.com/blog/what-is-a-stablecoin-and-how-it-works/ which allows for fast and inexpensive transactions. Users can send and receive TUSD quickly and easily, with minimal transaction fees. This makes it a popular choice for traders who need to move funds quickly and efficiently, particularly in volatile market conditions. With the recent phenomenon known as the ‘stablecoin invasion,’ demand for stablecoins is continuing to grow.

Examples of Stablecoins

A Ponzi scheme is a type of fraud that generates returns for investors with funds from new investors and eventually collapses when new investors stop making investments. This means the value of these assets can quickly implode if new users stop coming. Non-collateralized or seigniorage-style stablecoins destroy and inflate supply on-chain to maintain their peg. No collateral is used to mint these stablecoins as they are self-collateralized. The price lowering to $0.70 shows that there is more supply than demand for a stablecoin. The algorithm buys stablecoin A with seigniorage, reducing supply and bringing the price back to $1.00.

Whenever the holder of a stablecoin wishes to cash out their tokens, an equal amount of the collateralizing assets is taken from the reserves. Although popular stablecoins like Tether, USD Coin, DAI, and Binance USD all sit among the landscape’s largest cryptocurrencies based on market capitalization, their roles are largely understated. The major stablecoins players are the issuers of Tether, USDC and Binance, the most popular stablecoins by total value. But some expect banks to launch their own stablecoins, perhaps new digital versions of today’s commercial deposits. But even if banks don’t issue their own stablecoins, it’s likely there will be increasing integration of stablecoin-related services within traditional banks via crypto-bank partnerships.

Little to no volatility

This may mean stablecoin providers come under scrutiny as their cryptocurrencies displace traditional fiat currencies while providing new forms of financial products and platforms. In particular, protocols demand that the users either provide additional collateral or reduce the amount of stablecoins held in order to meet the minimum collateral requirement. Should the user fail to take these actions, the protocol relies on smart contracts and economic incentives of users to guarantee that all circulating stablecoins are appropriately collateralized. In particular, the smart contract needs to find sufficient resources to buy back circulating stablecoins and burn them. Doing so ensures that all the stablecoins in circulation are appropriately collateralized. One additional strategy to raise resources is to sell rights to future revenues against circulating stablecoins.

Besides his extensive derivative trading expertise, Adam is an expert in economics and behavioral finance. Adam received his master’s in economics from The New School for https://www.xcritical.com/ Social Research and his Ph.D. from the University of Wisconsin-Madison in sociology. He is a CFA charterholder as well as holding FINRA Series 7, 55 & 63 licenses.


Risk premiums represent the additional compensation investors get for the added risk of investing in an asset (i.e., stablecoins). The risk premiums lower the value of stablecoins compared with their peg, which means buying cryptocurrencies with stablecoins becomes slightly more expensive than with fiat currencies. Stablecoins backed by fiat currencies maintain reserves in fiat currencies like the U.S. dollar. For every token in circulation, fiat-backed stablecoins often have one dollar in reserve — either in cash or cash equivalents. Government-issued fiat currencies remain stable through the actions of controlling authorities like central banks, which ensure their currencies’ prices remain relatively stable.

what is a stablecoin in cryptocurrency