What are the main types of stablecoins?

Fiat-collateralized stablecoins

Fiat-collateralized stablecoins are backed by an equivalent value of a fiat currency held in reserve. This means that for every stablecoin in circulation, there is a corresponding amount of fiat currency held in reserve to back it. This helps to ensure that the stablecoin maintains its value and is less volatile than traditional cryptocurrencies.

An example of a fiat-collateralized stablecoin is Tether (USDT), which is pegged to the US dollar. Tether is the largest stablecoin by market capitalization, and it is widely used as a medium of exchange on cryptocurrency exchanges.

Crypto-collateralized stablecoins

Crypto-collateralized stablecoins are backed by an equivalent value of a cryptocurrency held in reserve. This means that for every stablecoin in circulation, there is a corresponding amount of a cryptocurrency held in reserve to back it. This helps to ensure that the stablecoin maintains its value and is less volatile than traditional cryptocurrencies.

An example of a crypto-collateralized stablecoin is DAI, which is pegged to the value of the Ethereum. DAI is created by using smart contracts on the Ethereum blockchain and is used as a medium of exchange in decentralized finance (DeFi) applications.

Commodity-backed stablecoins

Commodity-backed stablecoins are backed by an equivalent value of a commodity such as gold. This means that for every stablecoin in circulation, there is a corresponding amount of the commodity held in reserve to back it. This helps to ensure that the stablecoin maintains its value and is less volatile than traditional cryptocurrencies.

An example of a commodity-backed stablecoin is the Paxos Gold Token (PAXG), which is pegged to the value of one fine troy ounce of London Good Delivery gold.

Algorithmic stablecoins

Algorithmic stablecoins use smart contract algorithms to maintain price stability. Instead of being backed by a physical asset, algorithmic stablecoins use a series of smart contracts to manage the supply of the stablecoin in order to maintain its value.

An example of an algorithmic stablecoin is Ampleforth (AMPL), which uses a mechanism called “rebase” to adjust the token supply in response to changes in demand. This helps to maintain the token’s value relative to a basket of goods.

Each type of stablecoin has its own unique characteristics and uses. Fiat-collateralized stablecoins are backed by an equivalent value of a fiat currency, crypto-collateralized stablecoins are backed by an equivalent value of a cryptocurrency, commodity-backed stablecoins are backed by an equivalent value of a commodity, and algorithmic stablecoins use smart contract algorithms to maintain price stability.

How do Stablecoins Work?

Price stabilization mechanisms

Price stabilization mechanisms are used to maintain the value of a stablecoin relative to the asset it is pegged to. This is typically achieved through the use of smart contracts and other technology that automatically adjusts the supply of the stablecoin in response to changes in demand.

For example, the MakerDAO system, which issues the DAI stablecoin, uses a mechanism called “over-collateralization” to ensure that the value of DAI remains stable. This is done by requiring users to deposit a larger value of Ethereum in order to generate DAI. If the value of DAI falls below its target value, the system automatically sells off some of the collateral to bring the value back up.

Reserve management

Reserve management refers to the process of maintaining and managing the assets that are held in reserve to back a stablecoin. This includes ensuring that there is always an adequate amount of assets to back the stablecoin, as well as monitoring and accounting for changes in the value of the assets.

For example, a stablecoin issuer may hold a reserve of US dollars in a bank account to back a stablecoin that is pegged to the US dollar. The issuer will need to ensure that there is always enough money in the account to cover the total value of the stablecoin in circulation, and will need to account for changes in the value of the US dollar.

Stablecoins work by being backed by an equivalent value of a fiat currency, cryptocurrency, commodity, or other assets. Price stabilization mechanisms are used to maintain the value of a stablecoin relative to the asset it is pegged to, and reserve management is used to maintain and manage the assets held in reserve to back a stablecoin.

Highlights:

• Stablecoins are backed by an equivalent value of a fiat currency, cryptocurrency, commodity, or other assets to maintain their value and stability.
• Price stabilization mechanisms are used to maintain the value of a stablecoin relative to the asset it is pegged to, through the use of smart contracts and other technology.
• Reserve management is used to ensure there is always an adequate amount of assets to back the stablecoin and monitor and account for changes in their value.
• Collateralization methods include fiat-collateralized, crypto-collateralized, commodity-backed, and algorithmic stablecoins.

Highlights:

• Stablecoins can be classified as fiat-collateralized, crypto-collateralized, commodity-backed, and algorithmic stablecoins.
• Fiat-collateralized stablecoins are backed by an equivalent value of a fiat currency held in reserve, an example is Tether (USDT).
• Crypto-collateralized stablecoins are backed by an equivalent value of a cryptocurrency held in reserve, an example is DAI.
• Commodity-backed stablecoins are backed by an equivalent value of a commodity such as gold, an example is Paxos Gold Token (PAXG).
• Algorithmic stablecoins use smart contract algorithms to maintain price stability and are backed by a series of smart contracts, an example is Ampleforth (AMPL).
• Each type of stablecoin has its own unique characteristics and uses.