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What Is A Stablecoin? Fundamentals

Cryptocurrency assets have become a tool for trading and savings instead of entertainment for geeks. It is not without flaws, the main of which is volatility. Cryptocurrency is not secured by anything, its value depends only on the belief of users in the coin’s appreciation. Volatility and instability do not allow digital assets to take the place of fiat. Proponents of traditional approaches to investment and trading use familiar tools. To reduce volatility, coins backed by material values have been created. Stablecoins take their place in the list of cryptocurrencies. They are not like virtual money in the usual sense. Coins are used for different purposes. They attract users who avoid the volatility of cryptocurrencies.
The concept of "stable coin" means that the rate does not depend on standard factors (news background, user confidence, opinion leaders’ statements), but is tied to one of the assets: fiat money, other cryptocurrencies or material values (gold, oil, minerals).
The first virtual currency was created in 2009. It was Bitcoin that was developed by Satoshi Nakamoto (an unknown programmer or group of people). Later, forks based on it, other coins and tokens appeared. Since the launch of the first cryptocurrency, people have been arguing about the future of digital assets that can replace fiat money in different cases:
Payment instrument.
Trading tool.
A store of value or capital accumulation.
Proponents call Bitcoin the “new gold” and an alternative to fiat. The main argument of opponents of virtual money is its volatility. The value is too dependent on external factors. It is affected by:
News background.
World events.
The attitude of states, companies, opinion leaders.
The lack of centralized management excludes manual regulation of the exchange rate, as is the case with fiat money. Cryptocurrency reflects global economic and political events.
While skeptics doubted virtual money, an ecosystem emerged with enterprises, exchanges, payment services, decentralized applications, and blockchain platforms. Various methods have been used to reduce the volatility of digital assets.
Then, a stablecoin was developed. This is a symbiosis of virtual and fiat money. Material values, currencies (dollar, euro, yen and others) serve as collateral. A stablecoin is pegged to by fiat currency or another crypto asset in a 1:1 ratio. Deviations are allowed, but the rate is maintained as long as the coin exists. Market fluctuations, other factors do not affect the price of the token.

Why Do We Need Stablecoins? 

The goal of stablecoin developers is to reduce the volatility of traditional virtual money. It is achieved by linking the stablecoin rate to one of the assets with a constant price. When a user wants to keep savings, he chooses secured tokens. For trading, volatile assets are better from the point of view of “higher risk – more profit”.
Since the 70s of the XX century fat currencies are also not backed by anything. Until 1944, the "gold standard" was used. The rate of each national currency was tied to the precious metal. From 1944 until 1978, the key currency used was the US dollar backed by gold. The rate of other monetary units was pegged to USD. Further, all countries abandoned the existing system. Now the exchange rate is calculated using a complex formula, it depends on supply and demand. But traditional money is not provided with material values.
Top stablecoins take advantage of gold:
The exchange rate is stable, tied to the unit price of the collateral.
They are reliable means of accumulation. There are no sharp fluctuations in the exchange rate.
Stablecoins have one, but a significant drawback. Unlike bitcoin and other altcoins, there is no principle of decentralization.
Stablecoins allow all standard operations similar to fiat money. Main functions include:
Payment instrument.
Investment tool.
A store of value or asset.

List of Stablecoins

List of stablecoins include tokens tied to fiat money or material values (oil, gold, silver, palladium), backed by other coins, not tied to any asset, the rate is supported by the issuance of coins (also called algorithmic).
The value of a coin depends on the collateral currency. If the dollar falls, then the cryptocurrency pegged to it will also become less attractive to investors.
The best stablecoins serve as a store of value. That being said, there are many popular secured coins that help bring the digital world closer to the real one. These assets serve as a universally understood means of measuring price.
Large investors can transfer savings into virtual money and trade. Stablecoin works in the opposite direction. If a trader has a lot of coins, but does not want to withdraw to fiat yet, then he uses secured assets. They save money during times of increased market volatility.
Examples of stablecoins’ varieties include:
Fiat Backed
The simplest and most common type of stablecoin. The issuer issues coins usually at a ratio of 1:1 to fiat currency. For example, a company has assets in the amount of $5 million. For this amount, it issues 5 million coins that can be exchanged for other currencies, sold, and stored.
In simple terms, stablecoins backed by fiat money are IOUs. The owner of the token can at any time present it to the issuer and receive currency in return.
The depository for fiat collateral is a bank. Issuing companies hire auditors to check the availability of money, to draw up reports. This is a reliability criterion for potential users. The recent scandals with Tether, which failed to prove the backing of its USDT crypto asset, undermined faith in the reliability of stablecoins.
Many fiat-backed coins use the USD dollar. It is the most popular currency in the world. Many stablecoins are associated with the best crypto exchanges that act as development initiators or issuers (BUSD, GUSD, USDC, USDT and others).
Collateralized coins are tokenized fiat. The resulting symbiosis has the advantages of two systems: exchange rate stability and blockchain capabilities. Popular assets include Tether (USDT), TrueUSD (TUSD), Paxos and others.
Backed by Cryptocurrencies
This solves the main problem of fiat-backed tokens, the loss of decentralization. The money is kept in banks, which are regulated by the financial institutions of the country of registration. Cryptocurrency does not have a single governing body. The main advantage is decentralization. Therefore, stablecoins are issued with the provision of coins for popular projects (Bitcoin, Ethereum and others).
The problem of high volatility is solved by creating a reserve capital with a multiplicity of at least 2. This will allow you to maintain the course when the price falls.To purchase an asset, you need to request the required amount and transfer the equivalent to collateral in the required ratio. Further, the initiator receives a stablecoin to the account. The purchase is made through smart contracts.
There are stable coins without support. The exchange rate is adjusted through the seigniorage process. This is a volume control procedure by additional emission of other supporting coins. If it is necessary to reduce the rate, the developer issues coins, to increase, it destroys some of them. That is, an excess or shortage is created, supply and demand are regulated.
Such stablecoins are also called algorithmic. Smart contracts are used for control. There are price stabilization systems that are created in advance and included in the protocol.
Algorithmic tokens operate on the blockchain of a collateral cryptocurrency, most commonly Ethereum. The user transfers coins that are blocked in a smart contract, and a stablecoin is created based on it. When the tokens are redeemed, the owner gets his Ethereum back.
This is a complex stablecoin format. They are used within the DeFi ecosystem.
Benefits of algorithmic stablecoins:
Independence from fiat or digital currencies.
No collateral reserve is needed, which is beneficial for the issuing company.
The disadvantages of such tokens include:
Low stability. The price of an asset depends on the general situation on the market and is affected by external factors.
Demand among investors is low, you need to constantly support them through advertising campaigns.
With commodity supply
Another category of stablecoins is a cryptocurrency backed by material assets. Gold, silver, oil and other goods are used. The pledge is kept in one of the certified depositories or banks. The essence of such assets is no different from fiat-backed tokens, only other values are used instead of money.
The user of a commodity-reinforced coin essentially owns this property, expressed in digital form. If desired, you can exchange tokens for real gold. There are different rules for buying and selling, which are not always profitable and convenient.
The advantage of such assets is the ability to work more easily with gold, oil and other commodities. Commodity-backed coins are tokenized property.

Top Stablecoins Benefits 

Financial institutions of various levels of ownership at first did not consider cryptocurrency as a threat to their existence. But over time, it became clear that the blockchain is able to change many approaches, including in the banking sector. Stablecoins fit perfectly into the philosophy of traditional financial institutions. In doing so, they bring an element of innovation. 
Standard bureaucratic institutions are slowly becoming part of the digital world. While banks are only testing new opportunities, they are trying to create virtual money. It is impossible to talk about a separate type of stablecoins. These are fiat-backed stablecoins.
Central banks also see digital assets as a threat. They are worried about the stability of the financial network based on centralization, monopoly in the issuance of money with a complex system of rates. 
At the same time, many countries are developing digital currencies of national banks (CBDC).  This virtual money format is vaguely similar to fiat-backed stablecoins. Assets are being tested, none of the states wants to be left behind in the introduction of new technologies.

Prospects for Stablecoins

The digital world is developing and transforming under the influence of various factors. The best stablecoins occupy a special place in the ecosystem of decentralized assets. They serve as a kind of symbiosis between cryptocurrencies and fiat money. Provide fiat input for trading. They allow you to wait out the period of volatility of popular coins and tokens.
Some stablecoins may disappear under the influence of other projects. New developments will appear, including with the participation of the banking sector, public financial systems of different countries.
There may be a conflict of interest between fiat-backed stablecoins and CBDCs, which are essentially similar. At the same time, the latter have support in the form of the administrative resource of the Central Banks. CBDCs allow the government to control the financial system and take full advantage of the digital world with high transaction speeds and low fees.
In the fight against the cryptocurrency of central banks, algorithmic stablecoins, which are not backed by anything, may come to the fore. Rate stabilization is carried out with the help of additional emission of accompanying coins (for example, Terra for TerraUSD), which is controlled by smart contracts.