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What are Stablecoins?
Stablecoins are cryptocurrencies designed to minimize the volatility of the price of the coin, they can also be called “stable” asset or basket of assets. A stablecoin can be pegged to a crypto, fiat, or to commodities. Stablecoins are exchangeable in currency, commodities, or fiat money are said to be backed, whereas those tied to an algorithm are referred to as seigniorage-style or simply not backed.
BACKED STABLECOINS are not necessarily centralized since there may be a network of decentralization and commodity holders rather than a central control system.
Advantages of stablecoins backed by assets are first of all stability by assets itself that fluctuate outside of the cryptocurrency space reducing drastically all financial risks and bearish market bloodbaths. Bitcoin and all other altcoins are highly correlated and volatile , so that cryptocurrency holders cannot escape bearish price falls without escape from the market, escaping to stablecoins may be one of the only emergency exit a Hodler may have. Furthermore stablecoins are unlikely to drop below the value of the physical asset, due of course to arbitrage.
Backed stablecoins are subject to the same volatility and risk associated with the backing asset. If the backed stablecoin is backed in a decentralized manner, then they are safe from scams or thefts, but if there is a central vault, they may be stolen and suffer also a correlate loss of trust into the Stablecoin’s mechanism.
We can categorize Backed Stablecoins in 3 main categories:
Stablecoins Backed by commodities such as precious metals are much less affected by inflation to than the fiat backed stablecoins as It is much more difficult to mine gold or silver than it is to mint dollars. Commodities backed stablecoin’s value is fixed to the commodities and is also more or less redeemable for it, the amount of the commodity used to back the stablecoin must reflect the circulating supply of the stablecoin itself and it is often regulated by a financial institution.
The value of Stablecoins Backed by Fiat is based on the value of the backing currency, which is commonly held by a third-party regulated financial entity. The trust in the custodian of the backing asset is essential for the stability of price of the stablecoin. Fiat-backed stablecoins can be exchanged and are redeemable. Maintaining the coin’s stability reflect the cost of the maintenance of the reserve and the cost of legal compliance, licensing, Auditions and the Business infrastructures. Cryptocurrencies backed by fiat money are the most common and were the first type of stablecoins created, their value is pegged to one or more currencies on a fix ratio, the tether is realized off-chain from Banks or other institutions responsible to be the depositary of the backed currency which amount must reflect circulating supply.
Stablecoins backed by a Cryptocurrency are issued with cryptocurrencies as collateral, which is very similar to fiat-backed stablecoins with a significant difference between the two types, the fiat based collateralization is typically done off the blockchain, on the other hand the cryptocurrency based one is done directly on the blockchain, using smart contracts in a more decentralized way. To prevent sudden crashes, a user who takes out a loan may be liquidated by the smart contract should their collateral decrease too close to the value of their withdrawal. The price stability is achieved through introduction of supplementary instruments and incentives and the supply is regulated as well on the blockchain.
NOT BACKED STABLECOINS or Seigniorage-style coins use algorithms to control the stablecoin’s supply similarly to what a central bank may do, they are a much less popular form of stablecoin, all the adjustments are made on the blockchain as the value is fully controlled by the algorithm.
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