Stablecoins make their market entrance only after a few years of Bitcoin. They are considered an essential part of the crypto trading process.
Unlike regular cryptocurrencies, stablecoins maintain a fixed unit price at all times. This article is going to discuss various types of stablecoins in detail.
Types of Stablecoins
There are four basic types of stablecoins mentioned as under:
- Algorithmic Stablecoins
- Commodity Stablecoins
- Crypto Stablecoins
- Fiat Stablecoins
- Algorithmic Stablecoins:
Algorithmic stablecoins do not depend on traditional asset reserves or cryptocurrencies to back their value as collateral. On the contrary, these stablecoins achieve price stability using a specialized algorithm that controls their supply.
In simple words, when the total value of the stablecoin project rises in the main market, the algorithm mines more coins to bring the price down to the fixed unit value. In the same manner, when the overall price of the stablecoin market cap decreases the algorithm burns stablecoins to maintain the fixed unit price.
- Commodity Stablecoins:
Commodity stablecoins are backed by commodities such as gold, silver, oil, corn, and other traditional options in this category. Since gold is widely accepted as a store of value all across the world, it has remained one of the most popular choices for backing commodity stablecoins.
It is worth noting that investors who wish to seek an investment in both crypto and gold may do so by investing in this type of stablecoin.
PAXG and Tether Gold are two of the most popular gold-backed stablecoins. In the case of PAXG, investors have the option to redeem their stablecoins in exchange for real gold in a proportional amount of their holdings.
- Crypto Stablecoins:
Stablecoins are also backed by a cryptocurrency or a basket of various cryptocurrencies. Usually, the stablecoins that are backed by crypto make use of smart contracts to keep track of the price changes in the crypto-backed holdings.
Cryptocurrency stablecoins do not maintain their cryptocurrency reserves in centralized wallets but lock them on a blockchain using smart contracts.
Every buyer who wishes to purchase some stablecoin has to lock a required amount and type of cryptocurrency in the smart contract. Eventually, the buyer will receive stablecoins in their wallets equal to the value of their locked cryptocurrencies. DAI is a type of crypto-backed stablecoin.
- Fiat Stablecoins:
Fiat stablecoins are backed by fiat currencies such as USD, GBP, or Euro, etc. In some cases, stablecoins may also be backed by cash equivalents, debt, and other liquid investment options.
Fiat stablecoin reserves are usually stored and warranted by a traditional custodial such as banks or financial institutions. Most fiat stablecoins are backed by fiat currencies in a 1:1 ratio.
Stablecoins have remained a debated topic within the cryptocurrency community. Most professional investors emphasize the importance of stablecoins for locking and preserving their realized profits from crypto trading.