What Is a Stable Coin?
A stable coin is a type of cryptocurrency that is not subject to the same market volatility found in the day-trading varieties, such as, Bitcoin or Ethereum. This new variety of coin has the potential to completely transform the digital currency investments topography.
Named for the stability and steady valuation they offer, stable coins are not in the buy-and-hold class. Stable coins encourage spending. Though they may accrue value in the long view, they're not a short term commodity. Don't expect them to jump from $1US to $100US in a 24-hour period.
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Cryptocurrency operates on the Internet, and is not regulated central banks or governments. It offers autonomy and security, but, until now, has proven unreliable as an investment.
“Cryptocurrencies excelled at the first,” says Haseeb Qureshi, GP at Metastable Capital. “But, they cannot store value effectively if their price fluctuates by 20% on a normal day."
The stable coin solves the mercurial nature of day traded currencies.
Stable coins are price-stable digital currencies, and maintain the market price in the manner of fiat currencies.
How does stable currency work?
Stable coins receive value through the way they collateralize. This can happen in a number of ways:
Fiat currency-collateralized stable coin
Cryptocurrency-collateralized stable coin
Non-collateralized stable coin
What are fiat-collateralized stable coins?
Fiat-collateralized stablecoins are purchased and backed using fiat currency, such as: the US dollar, the Japanese yen, or the Euro. The value is tied to the value of the fiat currency backing it.
In one sense, purchase is a currency exchange using fiat.
What are crypto-collateralized stable coins?
Crypto-collateralized stablecoins are funded the same way that fiat-collateralized stablecoins are, that is, the value of the stable-coin is tied to the value of the purchasing coin. The difference is that the purchasing coin is digital currency. These is another important difference.
The way stable coin counters the volatility of digital currency by over-collateralizing or cushioning up the stable coin per cryptocurrency ratio.
For the purposes of this discussion, stable to cryptocurrency ration might be a 1/2 ratio. For every $1US of stable coin, the issuers of stable coin will back it with $2 of cryptocurrency.
Even if the cryptocurrency loses 50% of its value, this loss does not impact the stablecoin.
That example is only for the sake of argument. Each stable coin issuer will determine how much cryptocurrency their actuarial resources recommend. They might also develop contingencies, but this type of collateralizing approach has its problems. That is why stable coin advocates advise using the crypto-collateralization approach with caution.
If crypto-collateralization is necessary, one remedy will be to use a hybrid approach.
What are non-collateralized stable coin?
Non-collateralized stablecoins are stable coins not backed by collateral. This is a unique situation, but not uncommon in the banking industry as it pertains to fiat currencies.
The whole point of this practice is to ensure stability within a coin ecosystem. They, more often than not, may be part of a larger set of stable coin and used to maintain strict buying value for that coin.
Non-collateralized stablecoins are not backed by any [additional] collateral. The coin supply quantities are adjusted in proportion to the changes in coin value. This is not unlike the way central banks increase or reduce the printing of bank notes to keep the fiat currency stable.
Stable coin can remain stable through the use of a smart contract on a decentralized platform that can run in an autonomous manner.
One currency falling into this category is Basecoin. It’s value is held to $1 USD and follows a non-collateralized approach. It uses a consensus to reduce and increase the supply of the coin on a need basis.