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What are Stablecoins? And How Do They Function? | Coin Gabbar

24 Oct 2022 By : Abhinav Nagar
Southeast Asia’s Lar

Key takeaways

  • Stablecoins are cryptocurrencies that are backed by an asset. 

  • These coins are mostly backed by fiat currencies like dollars and Euros but there are some cryptocurrencies that are backed by commodities like gold. 

  • Stablecoins are an integral part of the current crypto ecosystems and hence an important part. 

Stablecoins are crypto tokens that are designed to maintain a stable price. They are mostly used for payments and transactions but can also be used as long-term savings tokens. Since their launch, stablecoins have proven to be extremely useful in the world of cryptocurrencies since they allow users to store value without worrying about price fluctuations. 

Stablecoins are usually pegged to another stable asset such as gold or fiat currency. This means that their price remains constant and does not fluctuate with the market as most other cryptocurrencies do. The stability of this digital token is ensured by various mechanisms which will be further elaborated on in this article.

What is a stablecoin?

A stable coin is a cryptocurrency that is designed to maintain a steady price. It usually maintains a fixed price relative to another asset, such as the US dollar, gold, or another cryptocurrency. This allows people to store value without worrying about volatility in the market, unlike with normal cryptocurrencies. 

Stablecoins are used as a form of digital cash, which can be quickly and easily transferred between people, businesses, and other organizations. They are also used for payments, such as for online purchases, travel tickets, and gift cards. Stablecoins are usually pegged to another stable asset such as gold or fiat currency. This means that their price remains constant and does not fluctuate with the market as most other cryptocurrencies do. The stability of this digital token is ensured by various mechanisms which will be further elaborated on in this article.

How do stable coins work?

Stablecoins are pegged to another stable asset. This means that their price is fixed relative to that other asset. The price of a stablecoin is not determined by the supply and demand in the market like with other cryptocurrencies. They are mostly backed by fiat money or other valuable assets. This creates a system of supply and demand. 

If the demand for the coin is greater than the supply, the price goes up. If the supply is greater than the demand, the price goes down. This creates a self-regulating equilibrium in the market. These coins are mostly collateralized. They are issued by a central authority that has a fiduciary responsibility to maintain a 1:1 ratio between the issued stablecoins and an asset like fiat money. This means that for every unit of stablecoin that is issued, there is an equivalent value of fiat money held in reserve by the issuing authority.

Functions of stablecoin

Payment Method

One of the most common uses of stablecoins is as a payment method. Stablecoins are mostly used for cross-border transactions. This is because they are not subject to fluctuations in the exchange rates of different currencies that can occur during a transaction. 

Long-term savings

Stablecoins are also used as a long-term savings token. This is because they are linked to assets that hold value such as gold, silver, or the USD. - Collateral: Stablecoins can also be used as collateral for take-out loans. This is a very useful feature since it allows stablecoin holders to maintain the value of their investment.

Trading:

Stablecoins are also used for trading. Since they are linked to assets that fluctuate in value, trading stablecoins can be profitable for investors. - Price speculation: Stablecoins can also be used for price speculation, like with other cryptocurrencies.

Stablecoins vs fiat money

Stablecoins are often compared to fiat money, especially by people who are skeptical about their value. While stablecoins are digital currencies that are not tied to any physical commodity, fiat money refers to paper money that is printed and issued by governments. 

Fiat money is used as a medium of exchange in the same way that stablecoins are. While both types of currencies have different benefits and drawbacks, they are both commonly accepted and used around the world. 

One of the main differences between fiat money and stablecoins is in the level of regulation. While fiat money is regulated by central banks, stable coins are mostly unregulated. This means that stablecoins are not backed by any government, and their value depends on the demand for the coin.

Tether: The most popular stablecoin

Tether is the most popular stablecoin, with a market cap of $68 billion. It is backed by the USD. The coins are issued by Tether Limited, a company based in the British Virgin Islands. It is the second most traded coin after bitcoin with $36 billion in daily trading volume. A tether can be used either as a long-term investment or as a way to transfer money between different countries without incurring high fees charged by banks and other money transfer services. Some exchanges also accept Tether as a method of payment. 

Tether has been controversial since it was first issued in 2017, with some people raising serious questions about its business practices and financial transparency. The concerns are mostly related to the fact that the issuing company never verifies its reserves or audits the amount of money held in reserve against the number of stablecoins that have been issued.

DAI: Another popular stablecoin

DAI is another popular stablecoin. It is backed by a combination of three different assets: fiat money, commodities, and other cryptocurrencies. The value of DAI is pegged to the US dollar. DAI is used by various decentralized exchange protocols, for trading, and as a payment method. DAI was established by the team behind Maker DAO. 

DAI is used as trading pair in many exchanges and is used to take out leverage, and short and long assets on a large scale by using decentralized services provided by the Maker DAO.

BUSD: the stablecoin of the Binance ecosystem

BUSD is the native stablecoin of the Binance ecosystem. It is pegged to the USD and is issued by the Binance platform. The Binance team promises to back each BUSD with $1 worth of fiat money. They also promise to regularly audit the underlying fiat reserves to ensure that the BUSD tokens are fully backed. Binance's stablecoin is used for paying trading fees on the Binance platform. 

It is used for investment and trading activities in the Binance ecosystem. Binance's stable coin can also be used for investing in ICOs. The Binance team plans to expand the use cases for BUSD outside the Binance ecosystem as well.

Wrapping up

Stablecoins are fiat-backed assets that are theoretically unaffected by the craziness that follows the crypto markets They ensure that investors and traders can keep their investments without worrying about the volatility in the market. 

Many stablecoins algorithmic or fiat-backed are not completely decentralized but are quite useful for everything from trading, to staking and governance.


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