Nothing to hide that cryptocurrency is not perfect yet, because there are inconveniences that the most vocal skeptics tend to bring up are unpredictable volatility, long transaction confirmations. Specifically when we talk about Bitcoin topic.
Discussions about Bitcoin and other proof-of-work , proof-of-stake cryptocurrencies struggling to serve as a medium of exchange has certainly discouraged in businesses to incorporate blockchain payments into their financial operations. However, new ideas emerged, and stablecoins were introduced as a means to deal with the aforementioned issues and improve on existing blockchain-based solutions.
In essence, stablecoin is precisely what it sounds like – a crypto asset that always maintains a stable value, yet retains all the properties that make cryptocurrencies tick as they do.
Let's see how do stable coins maintain the same course of value?
The way it achieves by collateralizing other real-world assets and pairing the stable-coin's value to them. As such, the value of stablecoins should never exceed the collateral in reserve, and therefore can (in most cases) be exchanged to the assets they’re pegged to at any time.
It's important to know that staple coins or non-mined ones and non pre-mined Instead, their total supply is always changing and reacting to the movements in the market. In order to control inflation, coins are burned when exchanged to the pegged asset. Likewise, when an asset is collateralized, newly created stablecoins enter the market.
Such an architecture allows traders, businesses and casual individuals to benefit from the properties of traditional digital currencies (e.g., low cost, high-speed, secure transactions) while eliminating the issue of highly volatile nature that most cryptocurrencies inherit.
Several different types of stablecoins currently exist. Even though the underlying principle is the same, the main difference is how a particular stablecoin maintains its value.
FIAT- backed Stable Coins :
As the name suggests, fiat-backed stable coins are pegged to a government-issued currences (e.g., U.S. dollars, Euros, Japanese Yen, etc.) in reserve, typically in a bank or other type of financial institution. That means the circulating supply of dollar-pegged stable coins should always be covered at 1:1 to the value of collateral held in reserve.
If fiat-pegged stable coin ends up exchanged back to the US dollar, then that coin is burned out of existence. Likewise, by collateralizing fiat, you’d create and add more stable coins to the total supply.
However, since fiat-backed stablecoin is an off-chain solution, and its collateral is held somewhere outside of the blockchain, it requires centralized governance and external audits to function properly and for a custodian to be deemed trustworthy. Although it sounds counter-intuitive if we agree to strive for decentralization, it is the most simple and easiest way to preserve strong stability.
Commodity backed Stable coins :
Commodity-collateralized stable coins are tied to the value of tangible assets, such as gold, precious metals, oil. Since holders of such coins have recourse to a tangible asset that is backed by real value, they can (usually) use them to redeem these commodities at any time.
There are several examples of such stable coins, for example, one coin is typically worth one predetermined unit of the referenced commodity (e.g., one ounce of gold or one barrel of oil). In fact, even governments attempt to issue their own commodity-backed coins, just like Venezuela did.
In February 2018, Venezuela launched its oil-backed digital asset called Petro. According to the officials, each coin represents a barrel of oil owned by the country. Eventually, Venezuela plans to issue even more stable coins which would be backed by the country’s gold and mineral reserves.
This coins is open to questions about the accuracy of the reserve holdings, which in turn may impact the value of the stable coins themselves.
Cryptocurrency-backed stable coins :
Less popular and more inflatable stable coins are backed by nothing else but cryptocurrencies themselves. Just as a like fiat-collateralized stable coin has a fiat tender as collateral, a crypto-collateralized stablecoin has cryptocurrencies locked up as collateral, such as Ethereum.
The key property of crypto-backed stable coins is that such stable coins require much higher collateral of 200% and more to compensate for the instability of the protected cryptocurrency, is required to make a protection commitment.
It is necessary in case the cryptocurrency which maintains the value of a stable-coin significantly drops in value. High collateral covers the stablecoin’s peg if such a situation arises.
On the other side,its called as on-chain solutions. That means they are fully decentralized and transparent for everyone to see what’s under the hood, also provide liquidity on-demand.
Seigniorage/Algo backed Stable coins :
Seigniorage style concept that corresponds to a fiat that does not require collateral in other assets. Its also called as algorithmic coins which are not backed by anything at all.
Seigniorage-style coins are governed with the help of complex algorithms. In simple words, coins depend on a mechanically-generated algorithm that is able to change the amount of supply if necessary in order to maintain the price of the coins attached to the asset, as a result bringing the price back to predetermined stable levels.
Even though there are no good examples of perfectly functioning Seigniorage-style stablecoins, they do get attention from curious crypto communities. The project had to be shut down due to several reasons focused on complying with US securities regulation.
Conclusion : Stable coins the future of cryptocurrencies?
Stable coins are relatively new in the blockchain industry, we will surely see a broader variety of them emerging in the upcoming years.
Always, its worth doing some research about the company, its history and principals and, to the extent possible, find reliable information on how collateral associated with a stable coin is held and what safeguards (e.g., auditing) are in place to verify a stablecoin's value.
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