What are Stablecoins?
Stablecoins are a type of token whose value is designed to be tied to another asset. Generally, stablecoins are the bridge between the fiat world and the crypto world.
There are different types of stablecoins:
- Fiat Backed: maintain a reserve of a certain fiat currency. Most fiat backed stablecoins are backed by the USD and some by other world currencies.
Ex. USDC. For every $1 in USDC, there is $1 held in a bank somewhere.
- Commodity Backed: collateralized by physical assets such precious metals like gold and silver or even oil.
Ex. PAXG. For every 1 PAXG token, there is 1 fine troy ounce (t oz) of a 400 oz London Good Delivery Gold Bar stored in the Paxos Trust Company’s vault.
- Crypto Backed: collateralized by another Cryptocurrency through Smart Contracts. Due to the high volatility of crypto, the reserves of the crypto need to exceed the amount of stablecoins issued.
Ex. DAI. For every $1 in DAI, there is $2 worth of ETH.
- Algorithmic: an algorithmic code controlling the change of supply and demand of (typically two) tokens, a stablecoin and a crypto token. Most of them are based on arbitrage opportunities when the coin is "off" the $1 peg. They are undercollateralized and don’t have independent assets in reserves to back the full value.
Ex. UST. Change in value of UST and LUNA to maintain a 1:1 peg.
Why would you need to use stablecoins?
- Lower the volatility in a portfolio
- Help to preserve your portfolio from losing too much value short term
- Able to sit with money ready to buy the dips instead of having to wait to transfer fiat to a central exchange (which has varying processing times), and then buy crypto with the stablecoin.
- You can earn yield on stablecoins
- You can take profit into stablecoins
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