A Stablecoin is a term used to describe a virtual asset pegged to another underlying reserved asset such as the U.S. dollar or gold. Software algorithms sometimes manage a Stablecoin to enforce price stability. Stablecoins, try to provide an alternative to the high volatility of many other cryptocurrencies, such as Bitcoin and Ethereum. Ideally, cryptocurrencies should maintain their purchasing power and have the lowest possible inflation; this drives coin users to spend rather than save. Stablecoins offer the speed and anonymity of cryptocurrencies like bitcoin but also provide stability in the same way government-issued fiat currencies do. There are three common types of Stablecoins: Fiat-Collateralized Stablecoins, Crypto-Collateralized Stablecoins and Algorithmic Stablecoins.

 

Fiat-Collateralized Stablecoins keep a fiat currency reserve as collateral to issue stable coins. One of the most famous stable coins, the USD Coin (USDC), is fully backed by the U.S. dollar and developed by the Centre consortium. Centre issues and redeems USDC without extra fees and is licensed as a money transmitter in the U.S. and as an e-money institution in Europe. However, most fiat-collateralized Stablecoins have reserves of U.S. dollars. Some other Stablecoins may opt for other forms of collateral such as gold, silver, crude oil and more.

 

Crypto-Collateralized Stablecoins hold other cryptocurrencies as collateral to issue coins. However, because common cryptos are very volatile, these Stablecoins have reserves in excess of the value of all the Stablecoins issued. For example, MakerDAO's Dai (DAI) Stablecoin is pegged to the U.S. dollar but backed by Ethereum (ETH) and other cryptocurrencies worth 150% of the DAI Stablecoin in circulation.[1]

 

Algorithmic Stablecoins may or may not hold any reserve assets. Instead, they have a computer program that controls the supply of the Stablecoin to retain its value. Some central banks that do not rely on reserve assets maintain prices in the same way. The only difference is that a central bank like the Federal reserve can publicly set Monetary Policies, which are very credible. Algorithmic Stablecoins can fall back on such measures. For example, TerraClassicUSD (USTC) is an algorithmic Stablecoin that was supposed to be pegged 1:1 with the U.S. dollar. However, on May 11, 2022, its price dove by more than 60%.

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Stablecoins are under heavier scrutiny by regulators; new American crypto laws could require Stablecoin issuers to hold proper reserves and disclose their holdings. Lawmakers hope that this will prevent Stablecoin holders from significant panic selloffs.

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[1] MakerDAO “A guide to DAI stats, https://blog.makerdao.com/a-guide-to-dai-stats/."