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What Is A Stablecoin? How Does A Stablecoin Work

Regardless of whether you are a novice or an expert on the subject of cryptocurrencies, venturing into the world of crypto where new technologies pop up now and then may seem nerve-wracking. Since the very beginning, virtual currencies have allowed anyone coming into association with them to establish an active stance in the growth of the crypto market. Volatility, however, has scared a lot of potential stakeholders away. To remedy that, stablecoins came into existence.

With the crypto industry being subject to constant volatility, the existence of stablecoins has made significant changes for those interested in participating without having to deal with raucous swings in the market. To explain it as simply as possible, if someone owns 5K in Bitcoin, instead of withdrawing that amount, they can simply “peg” the digital currency’s value to the value of another asset when the price drops.

Through a definite virtual currency that takes the form of USD, EUR, or any other asset considered secure, market participants can finally breathe a sigh of relief just as market volatility starts to make an appearance again.

In this article, we learn the basics of stablecoins; what it is, how it works, and its importance in the cryptocurrency community.

(Stablecoins: an introduction)

Stablecoins, to put it simply, are designed to generate a crypto token accompanied by a stable price. A stablecoin is a virtual asset that is intended to maintain a fixed value against a pegged traditional asset class. What it does is brings the price volatility down whereby attaching its value to a conventional asset – for example, a mixture of currencies like a singular fiat currency or other assets holding value. Stablecoins are also associated with other prominent exchanges or crypto projects.

Stablecoins are aimed at creating a secure and stable environment for increasing the adoption of digital currencies and combat the speculative nature of digital assets. Cryptocurrencies offer dual benefits, i.e., the safety and decentralized nature of virtual currencies, along with the stability aspect of fiat currencies.

The stablecoins with the greatest market cap hold a value of precisely 1 USD at any moment (with slight fluctuations being a given). This causes them to be a lot more stable compared to the entire crypto market, which happens to be volatile in nature.

Although they show great potential in terms of revolutionizing the present international financial landscape, stablecoins are still in their formative years. It may take some time before they are utilized normally in the crypto industry.

(How Stablecoins Work)

We now know that a stablecoin’s value is associated with the value of another, more conventional asset. But are they valued at the set pegged price? In an answer to this, most stablecoins keep collateral the same as the value they claim their virtual currency is pegged to.

Collateral can be in numerous different forms when you consider stable coins. These forms include commodities, fiat money, and of course, crypto. The most popular form of collateral is fiat money (inconvertible paper money, in other terms), USD and EUR in particular. Other assets can also be considered collateral such as gold and crypto baskets. Another rather uncommon example is stablecoins being backed solely by an algorithm. Some stablecoins also offer interest, e.g., 4% a year, for investors holding them in a compatible crypto account.

The most common stablecoins are the ones offering the most in terms of stability, therefore, the most predictable, free-of-risk asset in the crypto market.

The most stable stablecoins are, by far, the best in relation to maintaining their collateral frequently all the while offering a level of consumer confidence and transparency.

Fiat money works the easiest when an investor considers holding collateral, otherwise, it may prove tricky to some.

– The investor buys 5 USD worth of a stablecoin, the stablecoin managing company then, in response, generates one corresponding stablecoin.

– When the investor sells a stablecoin worth 5 USD, the stablecoin managing company decimates one corresponding stablecoin.

The main motive for the stablecoin managing company in question is to provide sufficient liquidity all the while maintaining a balance in their books to guarantee consumers’ confidence in their offered stablecoin.

In terms of trustworthiness, stablecoins do not have the same privilege as blockchains, as they have to keep a tight shift to maintain control over their stablecoin supply, and simultaneously manage an asset portfolio. For that reason, they are fundamentally centralized.

(Are they Worth it?)

Stablecoins are worth it in the sense that they offer stability in an otherwise unpredictable market. True to their name, they offer the very same value to digital currency investors, exchanges, and traders as fiat money offered to applicants in conventional financial markets; that value is contingent on stability. While non-crypto investors find themselves allocating portions of their portfolios to market funds, cash, and government bonds; crypto investors turn to stablecoins whenever volatility is prevalent.

The reason why crypto investors tend to move to stablecoins is that staying in the crypto market enables them to trade faster without having to worry about waiting days to switch to fiat money. There is also the fact that not all crypto exchanges are compatible with fiat currencies. This leaves stablecoin as the only viable solution.

(Stablecoin Uses)

Following are the ways stablecoins can be used for one’s advantage:

  1. Trade Assets

Holding stablecoins does not require a bank account, making them simple to transfer. The value of stablecoins can be transferred around the world easily, even in regions with unstable local currencies as well as places where the US dollar is difficult to come by.

  1. Acquire Interest

Many stablecoins offer interest, which is also generally higher in value compared to what a conventional financial institution would offer.

  1. Cheap Fund Transfers

Many have transferred funds up to a million dollars worth of USDC (a USD Coin), that too with transfer charges less than a dollar.

  1. Minimized Volatility

The value of virtual currencies tends to fluctuate a lot. To rectify that, an asset pegged to a stable currency can offer traders surety that the value of their tokens will not be subject to predictability anytime soon.

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