Stablecoin, as the name suggests, is a stable digital currency. Assets such as fiat currency, cryptocurrency, or gold back the stablecoin, creating a low-volatile coin. It is a product that combines decentralization with the legal fiat currency used in society. As there are minimal drastic price fluctuations, stablecoin is more suitable as a medium of exchange.
The earliest stablecoin is USDT Tether issuing it in 2014, and its value is pegged to the US dollar. Tether claims that when a certain amount of USDT is issued, a corresponding amount of U.S. dollars will be deposited in its official account. Meaning, USDT tokens will be equivalent to the amount of U.S. dollars in their bank accounts. The exchange ratio is 1:1 and users can conduct fund inquiries on the Tether platform to ensure transparency. Such a mechanism gives users full protection and security.
In addition, there are other stablecoins such as USDC and DAI that users prefer. They are also pegged to the US dollar price and maintain an exchange ratio of 1:1.
Stablecoin’s Categories & Pros and Cons
Stablecoins usually separate into three categories: Fiat-Collateralized, Cryptocurrency-Collateralized, and Unsecured stablecoins. Fiat-Collateralized stablecoins such as USDT and USDC are the most popular stablecoins in the market. The disadvantage of this stablecoin is that it is a centralized coin. It is opaque and has no guarantee of storing funds or redeeming tokens. Questions about the collateral have been raised (such as the safety of reserve dollars and the exact amount of reserve dollars). However, the Fiat-Collateralized stablecoin has managed to prevail despite the uncertainty.
Cryptocurrency-Collateralized stablecoins are similar to Fiat-Collateralized stablecoins. The only difference is the means of collateral. DAI, for example, has cryptocurrency as collateral instead of fiat. The collateral itself is a decentralized cryptocurrency, so the credit problem is no longer an issue. This approach allows users to create stablecoins by locking up collateral that exceeds the total amount of stablecoins. However, the problem also lies in the collateral – the cryptocurrency’s value fluctuates greatly and may drop in value dramatically, affecting the underlying backed value of the stablecoin.
Unsecured stablecoins are also known as algorithmic stablecoins. These coins, such as UST, do not require any collateral to back them up. Its value anchoring comes directly through algorithms and smart contracts, which manage the supply of issued tokens and maintain stable prices by adjusting the total supply of the tokens. The downside of such stablecoins is that stability is often maintained by centralized mechanisms, or unclear and complex monetary policy. Most of the unsecured stablecoins can be highly volatile.
Why do we need stablecoins?
The cryptocurrency market is often volatile in comparison with fiat currency. Furthermore, the value of tokens can be much higher or lower depending on the situation. This makes it difficult for investors to store their digital cash. Stablecoins can solve this problem. The value of stablecoin is closely related to the underlying asset or fiat currency, which can provide stable valuations. Stablecoins can also maintain their stability through various mechanisms. Therefore, stablecoins can be considered a trusted asset in volatile markets.
Should we invest in stablecoins?
Stablecoins provide investors with a stable digital channel to keep their profits locked in. Stablecoins can provide liquidity. However, stablecoins are mainly a medium of exchange and collateral, and cannot generate a lot of returns for investors.
Conclusion
Despite the limitations, stablecoins are still an important part of the crypto market. Stablecoins are cryptocurrencies that are typically backed by assets. By controlling various mechanisms, stablecoins can remain pegged within a preset price range. Therefore, stablecoins not only serve as a medium of exchange but are considered a safe source of long-term investment. MEXC Exchange provides various channels for investors to buy and hold such stablecoins.
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