What Are Stablecoins and How Do They Work?

what is a stablecoin

Adam Hayes, Ph.D., CFA, is a financial writer with 15+ years Wall Street experience as a derivatives trader. Besides his extensive derivative trading expertise, Adam is an expert in economics and behavioral finance. Adam received his master’s in economics from The New School for Social Research and his Ph.D. from the University of Wisconsin-Madison what is a stablecoin in sociology. He is a CFA charterholder as well as holding FINRA Series 7, 55 & 63 licenses. He currently researches and teaches economic sociology and the social studies of finance at the Hebrew University in Jerusalem. The information herein is general and educational in nature and should not be considered legal or tax advice.

what is a stablecoin

Although it requires one to trust the underlying smart contracts, this kind of stablecoin system is designed to run without touching the traditional financial system.. The stability of fiat with  the borderless, peer-to-peer https://www.tokenexus.com/ nature of cryptocurrencies and full transparency over their supply. This combination puts Stablecoins in the unique position of creating a bridge between cryptocurrencies and the traditional economy.

What Is the Purpose of Stablecoin?

Pegged to the U.S. dollar one-to-one, USDC claims to be backed by U.S. dollar assets held in U.S.-regulated financial institutions. Stablecoins are neither issued nor regulated by a central bank or government. Stablecoins aim to maintain their pegged rates using different means. Stablecoins can be backed by cash, cash equivalents, commodity values, or the value of other financial instruments to maintain their peg. Some even use complex algorithmic programs to maintain the peg by controlling supply, although this doesn’t always work.

This allows for more flexible and efficient use of reserves, but it also increases the risk of volatility. This creates a decentralised ecosystem that is regulated by the users themselves, as opposed to one issuer or third-party regulatory body dictating monetary policy. Users have to trust that all the network participants will act in the best interests of the group as a whole, which is one of the big draws of cryptocurrencies in general. TerraUSD (UST) was the biggest algorithmic stablecoin, reaching a market cap of more than $18.7 billion at its peak on May 5 before it began to plummet sharply after it slipped below its peg. Recent events have taught us that not all stablecoins are created equal.

How to Stake Stablecoins?

Stablecoins provide the same value to crypto investors and traders as fiat currency offers to participants in traditional markets—stability. For instance, while traditional investors might choose to allocate portions of their portfolios to cash or treasury bonds when volatility rises, crypto investors can move to fiat or gold-backed stablecoins. Collateralized stablecoins that rely on fluctuating assets such as other crypto assets can be risky so always DYOR (do your own research). They seek to provide fiat value and price stability in a blockchain environment where digitized (yet non-decentralized) cash may not be recognized. Although all stablecoins aim to maintain a pegged ratio to a given fiat currency, the assets they hold as collateral may determine the stability of their respective pegs. In the US, JPMorgan is in the early stages of exploring deposit tokens for cross-border payments and settlement.

  • In October 2021, the International Organization of Securities Commissions (IOSCO) said stablecoins should be regulated as financial market infrastructure alongside payment systems and clearinghouses.
  • Pegged to the U.S. dollar one-to-one, USDC claims to be backed by U.S. dollar assets held in U.S.-regulated financial institutions.
  • The Bank of England wants companies that issue stablecoins used mainly for payments, to issue them in a safe way.
  • If the price surpasses the value of the fiat currency, new tokens enter into circulation to reduce the stablecoin’s value.
  • They can track a normal currency in a variety of ways—chiefly by holding assets such as cash or government bonds to support the value of the coin.

Simply, they’ve been at the forefront of the digital payment revolution for over 20 years. But leading innovation in payments is an ongoing challenge that requires new technologies, something which PayPal is all too familiar with. The net result from this uncertainty would be reduced economic activity. It comes down to human psychology — people are less willing to spend an asset if they expect it to increase in value, while they’ll quickly spend a currency that is rapidly declining in value. The long term movement might be up – making your coffee relatively cheaper over time – but this doesn’t help consumers or businesses who need to budget on a day-to-day basis, for which stability is essential. If you switched to buying your €3 coffee in bitcoin every morning then its price would be constantly changing.

How does a stablecoin work?

PYUSD is a stablecoin pegged to the United States Dollar and issued by Paypal. To explain, via PayPal, you can always buy or sell 1 PYUSD for 1USD. Alternatively, top up your Binance cash wallet with other currencies to exchange the stablecoin of your choice.

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