What is a stablecoin?

what is a stablecoin

This value is then maintained by various means, commonly by holding a reserve of assets (like cash) as collateral. As the pegged asset changes in value (such as with inflation), so too does the value of the stablecoin. Mica, the EU’s flagship digital assets regulation, comes into force next year and Stenger said that SocGen’s stablecoin is built to align with the rules, adding that “very few stablecoins are compliant with Mica”. Presently Tether is the largest stablecoin, accounting for approximately 53% of the total stablecoin market capitalization. USD Coin (USDC) is the second largest stablecoin by market cap with around 31% of the market, followed by Binance USD (BUSD). Circle, the company behind USDC’s CEO said that much of the demand is from regular businesses, not just crypto traders as companies were quick to realize the benefits of stablecoins.

  • Most stablecoins are issued by an entity or company that is responsible for managing the issuance schedule and ensuring that they are holding enough assets in reserves to adequately back the stablecoin.
  • This also reduces central bank reliance on commercial banks to control the issuance of new money into the economy.
  • If a stablecoin loses its intended value and is unable to quickly recover it, it becomes functionally useless.
  • For example, a trader could use a stablecoin, like USDC, to buy Bitcoin on an exchange without having to worry about the volatility of the Bitcoin price.
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Since they lack volatility, they are great for borrowing, lending, and making payments especially abroad. They also provide immense liquidity to DeFi projects, and they bridge the gap between fiat and crypto as they are backed by real assets with real value. These coins are kept stable through a computer program running a preset formula; hence, its name.

What Kinds of Stablecoins Are There?

Unlike the types above, algorithmic stablecoins are typically uncollateralized. To illustrate how this works, let’s assume an algorithmic stablecoin’s price is pegged at $1. If this stablecoin’s price rises above $1, the algorithm creates new coins and puts them in circulation to deflate its price. If the price falls below $1, the algorithm “burns,” or removes, coins from circulation to increase its price. Similar to the types of stablecoins listed above, crypto-backed stablecoins are pegged to other cryptocurrencies. First, crypto-backed stablecoins are often run by decentralized companies or organizations through smart contracts.

what is a stablecoin

The purpose of a stablecoin goes beyond being just a financial contract. It is the evolution of both conventional payment systems and traditional, volatile cryptocurrencies. The crypto market’s most significant coins are also its most controversial.

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Bitcoin is not tied to anything beyond the supply and demand for BTC. Relying on an algorithm rather than cash reserves caused TerraUSD to lose its price peg during a major liquidity crunch in early 2022. UST relied on a sister token called Luna plus a huge reserve of Bitcoin to back its 1-to-1 peg. Traders exploited the algorithm that used Luna to maintain the value of UST in order to make quick profits, and the entire system crashed over a matter of days.

what is a stablecoin

Please appreciate that there may be other options available to you than the products, providers or services covered by our service. Usually, you expect to pay a transaction fee when buying or selling cryptocurrencies with an exchange. However, Coinbase does what is a stablecoin not charge commission fees when UK customers buy or sell USDC1. We believe everyone should be able to make financial decisions with confidence. Conventionally, this would require foreign exchange (FX) conversions with multiple banks and intermediaries.

How Do Stablecoins Work?

This allows for more flexible and efficient use of reserves, but it also increases the risk of volatility. USDC launched in September 2018 with the aim of providing a safe haven to traders in times of volatility, as well as letting businesses accept payment in cryptocurrencies, due to the stable price of USDC. Well, as we saw last year, a good reason to convert your money into stablecoins is if you expect your domestic fiat currency (say the Euro) to drop in value against the US Dollar due to economic or political reasons. This allows you to retain the value of your funds and the option to convert them back to your local currency later for a profit.

Time will tell if centralized stablecoins are the future, or if CBDCs will knock stablecoins out of the running. Then, of course, the final drawback comes from algorithmic stablecoins. Most stablecoins are issued by an entity or company that is responsible for managing the issuance schedule and ensuring that they are holding enough assets in reserves to adequately back the stablecoin. The four https://www.tokenexus.com/ largest stablecoin issuers are Circle, Paxos, Tether, and Binance. Second, because cryptocurrencies are usually more volatile than other assets, these organizations typically hold more in their reserves than the amount in circulation. For example, if Organization C has $10 billion of their ethereum-backed stablecoin in circulation, they will hold more than $10 billion of ethereum in reserves.

But, because stablecoins have a stable value, people may start using them more to pay for a wider range of things. Moreover, politicians have increased calls for tighter regulation of stablecoins. For instance, in November 2021, Senator Cynthia Lummis (R-Wyoming) called for regular audits of stablecoin issuers, while others back bank-like regulations for the sector.

  • A central entity holds the collateral and may also be subject to external financial regulation.
  • The Bank of England wants companies that issue stablecoins used mainly for payments, to be issued in a safe way.
  • For example, if Organization C has $10 billion of their ethereum-backed stablecoin in circulation, they will hold more than $10 billion of ethereum in reserves.
  • You also need to trust that the issuer has the reserves they claim to have.
  • Prior to the event, the TerraUSD project was widely regarded by crypto enthusiasts as one of the most exciting stablecoin innovations.