What are Stablecoins? A Beginner's Guide
With their value anchored not in the digital ether but in the tangible world of fiat currencies and commodities, stablecoins are the calm in the eye of the speculative storm that is cryptocurrencies. Now sporting a market cap of nearly $143 billion, they're not just a footnote in the $2.38 trillion cryptoverse—they're a headline.
But what is a stablecoin, what are its types, and how can you use one? Let's decode the DNA of these digital currencies and their most popular uses.
What is a Stablecoin?
A stablecoin is a type of cryptocurrency whose value is pegged to another asset. This other instrument can be a single (e.g., USD) or a basket of financial assets (e.g., USD, EUR, and GBP).
By following the value of other assets, stablecoins maintain a stable price and minimise the volatility-related risks of crypto assets. This is a crucial benefit, as most cryptocurrencies are highly volatile and can be subject to significant (and even extreme) price fluctuations in short periods of time.
While stablecoins lack cryptocurrencies' high volatility, they reside on the blockchain and work just like standard digital assets. Thus, they offer the same advantages, from cost-efficient and instantaneous transfers to cryptographic security and peer-to-peer (P2P) transactions.
Bitcoin Volatility vs Other Assets (source: charts.woobull.com)
What Are the Different Types of Stablecoins?
Most stablecoins follow the prices of major fiat currencies (e.g., USD, EUR, GBP). Others are pegged to the values of commodities like gold. To track the value of the underlying asset, they utilise various mechanisms to establish their pegs, which are based on each stablecoin type.
Multiple types of stablecoins exist on the crypto market based on the collateral or mechanism utilised for achieving price stability.
1) Fiat-backed
As the most popular type, fiat-backed stablecoins like USDT, USDC, and PYUSD employ physical collateral to establish and maintain a peg with the underlying asset. The company that issued the instrument holds these reserves in cash or cash equivalents (e.g., US treasury bills). While the goal is to mint exactly as many stablecoins as the value of the held reserves to achieve 1:1 fiat backing, the physical collateral's actual size depends on regulatory laws and the transparency of the issuer.
2) Commodity-backed
Commodity-backed stablecoins work very similarly to their fiat-backed counterparts. While they are issued by a traditional company and rely on physical collateral for price stability, commodity-backed stablecoins like Tether Gold (XAUT) and Paxos Gold (PAXG) follow the price of a commodity (e.g., gold), not a fiat currency.
3) Crypto-backed
On the other hand, crypto-backed stablecoins such as DAI achieve price stability on-chain without any physical fiat reserves. Instead, the stablecoin is collateralised with various cryptocurrencies through on-chain transactions and smart contracts. Also, they are issued by a decentralised autonomous organisation (DAO) instead of a traditional company.
As a result, crypto-backed stablecoins are transparent and decentralised. On the other hand, you can mint less stablecoins as the value of your digital asset collateral due to over-collateralisation, which is utilised in combination with different price stability mechanisms to mitigate volatility-related risks.
4) Algorithmic
Finally, algorithmic stablecoins rely on an algorithm and the issuer's native asset for price stability without maintaining any physical reserves. While this can make them more decentralised, their structure and historical cases significantly increase their systematic and financial risks. For example, the UST algorithmic stablecoin's depeg in May 2022 collapsed the Terra blockchain, wiping away Luna's $40 billion market cap and nearly $20 billion Total Value Locked (TVL) in DeFi.
Bridging Crypto with Fiat
Stablecoins bridge the gap between the fiat and crypto markets. They minimise cryptocurrency volatility and fulfil various use cases within the industry, from seamless cross-border payments to trading on exchanges.
Regarding the latter, you can currently access these different types of stablecoins on VALR:
Tether (USDT): As the world's top stablecoin, USDT continues to dominate the sector with a nearly $100 billion market capitalisation.
USD Coin (USDC): Issued by Circle, USDC is the second-largest stablecoin. It has a nearly $29 billion market cap, is regulated in the US, and is fully backed by physical reserves.
PayPal (PYUSD): PYUSD is the first stablecoin issued by a major US financial company. Launched in August 2023, it is also regulated in the US and has a $264 million market cap.
DAI: DAI, created by MakerDAO, is the first decentralised, crypto-backed stablecoin and has a market cap of over $4 billion.
On VALR, USDC is currently available on both the Avalanche and Ethereum networks. At the same time, eligible customers also have the chance to deposit USDC via USD SWIFT payments.
Ready to gain exposure to stablecoins through VALR, but don't have an account yet? Sign up below and get started in just a few minutes!
Frequently Asked Questions
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Trade facilitation. Think arbitrage across exchanges and quicker settlement times, all without the rollercoaster ride of typical crypto volatility. It's the crypto world's attempt at a "stable" medium of exchange—key for traders looking to park funds without exiting the crypto ecosystem.
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Four: fiat-backed (hello, USDT), commodity-backed (gold bugs, rejoice), crypto-backed (DAI's territory), and the high-risk, high-drama algorithmic (UST, anyone?). Each has its playbook for pegging value, from the concrete vaults of fiat reserves to the ethereal maths of algorithms.
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Depends. Fiat and commodity-backed are relatively stable, anchored by real-world assets. However, crypto-backed adds a layer of volatility from the underlying crypto collateral. Algorithmic? Buckle up—no physical backing means they're riding on market faith and algorithmic finesse, which can turn south fast (UST’s downfall is a cautionary tale).
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CBDCs are central bank digital currencies—think government-backed digital fiat. Stablecoins are crypto's answer to stability, minus the government stamp. CBDCs carry the full faith and credit of their issuing governments, while stablecoins rely on their backing assets or mechanisms for trust.
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Based on market capitalization, the top 4 stablecoins are USDT, USDC, DAI and FDUSD.
Risk Disclosure
Trading or investing in crypto assets is risky and may result in the loss of capital as the value may fluctuate.
VALR (Pty) Ltd is a licensed financial services provider (FSP #53308).
