Stablecoins are probably the closest bridge from the world of finance as most people know it to the digital currency world. They serve to create some stability in the very volatile crypto market and bring investors different options for leveraging and hedging risk. The stablecoin market exploded in 2020-2021 but many people still don’t fully understand them or how they work. Here’s a quick rundown of the various types, mechanisms, and use cases.
The 4 different types are Fiat-collateralized, Commodity-backed, crypto-backed, and algorithmic.
Fiat collateralized: The most common and easy to understand, it’s backed 1:1 by fiat currency the most popular being the U.S. dollar popular examples would include Tether and USDC.
Commodity-backed: This one is less popular but still exists, projects such as Paxos and DiamCoin are backed by the value of gold and diamonds.
Crypto-backed: Dai is a great example of this, it works with the MakerDAO and is backed by the crypto asset: Maker.
Algorithmic: These stablecoins not backed by any asset but keep their stability through smart contracts, the algorithm manages the supply of the coin by burning or adding to the circulation to keep the price pegged to the fiat it represents. Terra’s UST was an example of this and a miserable failure.
Stablecoins quickly found their use in the crypto industry as a medium of exchange and a store of value. Their use in Defi is unparalleled as they are used in almost every transaction. Stablecoins have also been used on staking platforms making them essentially a decentralized savings account but with much higher annual yields.
