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What is a Stable Coin?

February 16, 2022

A stable coin is a type of crypto currency that straddles the risk and volatility experienced in crypto currencies, with the relative stability of traditional fiat currencies like the U.S. $ or RMB Etc. 

The popularity of Stable Coins as an alternative to traditional fiat currencies is growing rapidly as they offer Privacy of Payments with crypto currency while being pegged to a traditional fiat currency. Stable Coins can also be pegged to commodities such as gold and silver. Even the most popular crypto currencies, like Bitcoin, experience market volatility with Bitcoin trading at approximately $30k in July 2021, up to $67k in November 2021 and back down to $35k in January 2022. If traditional fiat currencies were this volatile, they could potentially collapse a countries economy, so until, and if, crypto currencies become more stable, Stable Coins will be the safest least volatile form of crypto currency to use in the crypto currency arena. 

Stable Coin straddles the gap between traditional fiat currencies, controlled by Central Banks and decentralized crypto currencies. 

There are 3 distinct types of Stable Coin. 

Fiat collateralized Stable Coins. 

These Stable Coins are pegged against traditional fiat currencies like the U.S. $, but also against other commodities like gold and silver, and cover the issued number of crypto coins, providing collateral or reserve for those issued coins. This collateral or reserve is managed and held by independent custodians who are regulated and audited on a regular basis to ensure they comply with various country financial regulations. 

There are several Stable Coins pegged to traditional fiat currencies but the top 3 are: 

Tether (USDT), True USD (TUSD) and USD Coin (USDC). 

Crypto Collateralized Stable Coins. 

These Stable coins are backed and pegged to other crypto currencies and because of this and those crypto currencies volatility, these Stable Coins require larger amounts of collateral. That means more of those volatile crypto tokens need to be kept in reserve. These Stable Coins are backed by a basket of crypto currencies to spread the risk of volatility. 

What does “Centralized” mean in the context of Stable Coin? If for example you deposit $200 of Ethereum (ETH) to provide collateral for $100 of Stable Coins, the Stable Coins are 200% collateralized. If Ethereum’s (ETH) value fell by 25%, it would mean the Stable Coins would be valued at $150 which still covers the Stable Coins distributed. 

DAI tokens are a good example of a crypto collateralized Stable Coin, where users do not purchase DAI tokens per se, but create DAI in exchange for Ethereum (ETH) as a Collateralized Debt Position (CDP) locking the Ethereum (ETH) within the MAKER system. MAKER is a permissionless lending platform responsible for making DAI. 

Non-Collateralized Stable Coins 

This kind of Stable Coin does not rely on any reserves and does not peg against a traditional fiat currency, but they do have a working framework like that of a central bank, which attempts to retain a stable value. BASECOIN for example uses a consensus mechanism to manage the supply of tokens or coins on a need basis like how traditional fiat currency central banks print more money when required. 

So how do Stable Coin transaction’s function?  

They are smart contracts with terms of agreement directly between the buyer and seller (no middle entity), written directly into lines of computer code which exist across a decentralized blockchain network. The computer code controls the execution of the smart contract and transactions are trackable and irreversible. 

Stable Coins have an approximate market cap of $130 Billion. 

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