Stablecoins Explained

Key Takeaways

• Stablecoins maintain price stability by being pegged to fiat currencies (e..g USD), making them more suitable for daily transactions compared to volatile cryptocurrencies.
• Three main types of stablecoins exist: fiat-collateralised, crypto-collateralised, and algorithmic. Each has its own strengths and risks.
• Stablecoins play a crucial role in the crypto ecosystem, serving as a safe haven during volatile periods, facilitating cheaper and faster cross-border payments, and enabling innovation in DeFi and dapps.

Why Stablecoins Exist

Stablecoins are a type of cryptocurrency designed to mitigate the price volatility seen in digital currencies like Bitcoin (BTC) and Ethereum (ETH). Unlike traditional cryptocurrencies, stablecoins maintain a stable value by being pegged to external assets such as fiat currencies (like USD or EUR) or through algorithms that control supply and demand.

By maintaining price stability, stablecoins aim to solve one of the main issues that prevent the widespread adoption of other cryptocurrencies—volatility. This makes them suitable for everyday use, whether for transactions, remittances, or decentralised finance (DeFi) applications.

Stablecoins are now the dominant medium of exchange for blockchain-based transactions (Source: Nic Carter)

Three Main Types of Stablecoins

1. Fiat-collateralised stablecoins. Backed by traditional fiat currencies, like USD or EUR, held in reserve to maintain their value.
2. Crypto-collateralised stablecoins. Backed by other cryptocurrencies as collateral, often requiring over-collateralisation to maintain stability.
3. Algorithmic stablecoins. These stablecoins use algorithms and smart contracts to control supply and demand, maintaining their value without needing any collateral.

The most popular type of stablecoins are the fiat-backed ones—and by quite some margin. Nearly all of the outstanding supply of fiat-collateralised stablecoins is tied to USD. Examples of widely used stablecoins are USDC and USDT.

Type	Advantages	Disadvantages
Fiat-Collateralised	Easy to understand and widely used. Typically stable if reserves are properly audited.	Highly centralised. Requires trust in the issuer to maintain reserves and comply with regulations.
Crypto-Collateralised	More decentralised with smart contracts managing collateral. Transparent reserves visible onchain.	Complex system. Requires over-collateralisation due to volatility of underlying crypto.
Algorithmic	Decentralised without the need for collateral.	High risk of failure if the algorithm doesn't maintain the peg. Known for being unstable.

The Growth of Stablecoins in the Ecosystem

The use of stablecoins has surged in recent years, becoming a major part of the cryptocurrency ecosystem. Stablecoins have grown in demand due to their ability to combine the benefits of blockchain technology—such as transparency, security, and fast transactions—with the price stability of fiat currencies.

Their presence has expanded across multiple areas, particularly in DeFi. In DeFi, stablecoins are essential for liquidity pools, yield farming, and decentralised lending, providing a more stable alternative to volatile cryptocurrencies.

As more financial products and services shift to blockchain platforms, stablecoins are increasingly becoming a backbone for facilitating secure, fast, and stable transactions.

Conclusion

Stablecoins have become a fundamental pillar of the crypto ecosystem, providing a stable and reliable alternative to volatile digital assets. As they become increasingly used in DeFi and cross-border payments, stablecoins may help bridge the gap between traditional financial systems and blockchain technology.