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Stablecoins 101: What Are They, How Do They Work, How Many Are There?

Published May 10, 2022 20:39 Updated May 10, 2022 21:10
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Stablecoins are cryptocurrencies that have their values tethered to assets such as the U.S. dollar, precious metals such as gold, real estate and even other cryptocurrencies in order to maintain value.

They were created as a response to the crypto markets' well-known volatility, providing price stability through reserve assets. A cryptocurrency should continue to serve as a medium of trade and a means of storing wealth while maintaining its purchasing power over time. Stablecoins such USD Coin (CRYPTO: USDC) succeed where unstable cryptocurrencies like Bitcoin (CRYPTO: BTC) and Ethereum (CRYPTO: ETH) do not.

These dollar-indexed coins, unlike Bitcoin and Ethereum, are not intended for trading or investing. Rather, they're designed to make trading on numerous crypto exchanges smoother. Instead of buying Bitcoin with fiat currency, a user would purchase a stablecoin with the fiat and then exchange the stablecoin for another cryptocurrency.

The advantages are mobility, accessibility and security as these coins are not bound to centralized institutions or systems due to their decentralized structure.

Stablecoins can be associated with a specific crypto exchange such as USD Coin with Coinbase (NASDAQ:COIN) Global Inc (NASDAQ: COIN) and Tether (CRYPTO: USDT) with Bitfinex.

There are three types of stablecoins: fiat-collateralized, crypto-collateralized and non-collateralized (algorithmic); below are brief descriptions. (Definitions provided by corporatefinanceinstitute.)

Fiat-Collateralized Stablecoins

Fiat-collateralized stablecoins are backed by sovereign currency such as the U.S. dollar. It means that to issue a certain number of tokens of a given cryptocurrency, the issuer must offer dollar reserves worth the same amount as collateral.

Commodities such as gold can also be used here. The reserves are often maintained by custodians who function independently and are regularly audited for compliance. Cryptocurrencies backed by dollar deposits include Tether and USD Coin.

Some well-known fiat stablecoins are:

  • USD Coin
  • TrustToken
  • Tether (CRYPTO: USDT)
  • Gemini Dollar (CRYPTO: GUSD)

Crypto-Collateralized Stablecoins

The value of crypto-collateralized stablecoins is pegged to that of other cryptocurrencies. Since the underlying asset, in this case, is also a cryptocurrency, it is not conventionally safe and may also be highly volatile.

The term used to refer to such kinds of stablecoins is “over-collateralization.” It means that a relatively large amount of reserve cryptocurrencies may be needed to issue even a small number of tokens.

Some well-known crypto-backed stablecoins are:

  • MakerDAO (CRYPTO: MKR)
  • Synthetix (CRYPTO: SNX)
  • Reserve (CRYPTO: RSV)

Non-Collateralized (Algorithmic) Stablecoins

Non-collateralized stablecoins do not involve the use of any reserve asset. Instead, their stability is derived from a working mechanism, such as a central bank.

For example, the cryptocurrency base coin uses a consensus mechanism to determine whether it should increase or decrease the supply of tokens on a need basis.

Some well-known algo stablecoins are:

  • Terra (CRYPTO: LUNA): Learn more about Terra here.
  • Frax (CRYPTO: FRAX)
  • FEI USD (CRYPTO: FEI)

According to CoinMarketCap, there are 98 stablecoins in existence. Here are the top 10, ranked by market capitalization:

  • Tether: $83,172,427,823
  • USD Coin: $48,414,660,313
  • Binance USD (CRYPTO: BUSD): $17,246,290,409
  • Terra: $16,240,652,738
  • Dai (CRYPTO: DAI): $7,388,215,695
  • TrueUSD (CRYPTO: TUSD): $1,295,840,635
  • Pax Dollar (CRYPTO: USDP): $947,339,037
  • Neutrino USD (CRYPTO: USDN): $900,077,210
  • Fei USD: $419,300,349
  • USDD (CRYPTO: USDD): $256,691,157
  • © 2022 Benzinga.com. Benzinga does not provide investment advice. All rights reserved.

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