What is a stablecoin and how does it work?

The interest gained is called the “stability fee” which means that users will need to pay back the same amount of DAI if they want to withdraw Ether from the contract. As inherently stable crypto assets, stablecoins hold appeal for both the crypto and traditional credit markets. To buy stablecoins you’ll need an account with a crypto exchange or a digital wallet where you can what is a stablecoin and how it works buy crypto directly. Some services may not be available in all locations, so be sure to check whether the options you want are available where you live. Exchanges like Coinbase may offer some stablecoins, but such centralized exchanges may list fiat-backed versions only. For more options, you could use a decentralized exchange to swap any existing tokens for most stablecoins.

As noted above, in practical terms, stablecoins have made it easier to speculate in cryptocurrency markets. Their rapid growth in popularity is also the result of stablecoins’ use as collateral by decentralized finance lending and staking protocols. Fiat-collateralized stablecoins maintain a reserve of a fiat currency such as the U.S. dollar, as collateral assuring the stablecoin’s value. Other forms of collateral can include precious metals like gold or silver as well as commodities like crude oil, but most fiat-collateralized stablecoins have reserves of U.S. dollars. Stablecoins like Tether provide a low volatility digital asset that usually maintains a steady valuation.

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“The rewards received by the pool will be calculated based on a snapshot taken during each epoch. Delegation rewards will be automatically distributed to eligible $SHEN holders that held $SHEN during the epoch for which the rewards are distributed. The rewards from the pool will be distributed every 4th consecutive epoch and transferred to eligible $SHEN holders directly to their wallets without any additional action on their part. “While our main goal is to issue stablecoin for enterprises and merchants on COTI’s Trustchain, we also plan on being involved with stablecoin issued on other chains. Our long relationship with Cardano, leading to an equity investment by their ecosystem fund, has created the opportunity for COTI to become the official issuer for Djed, Cardano’s stablecoin. While cryptocurrencies and the crypto ecosystem may present interesting and rewarding opportunities, many cryptocurrencies are extremely volatile.

The lender subsequently announced the decision to halt withdrawals after similar moves by Celsius Network and Voyager Digital. “Owning 1 UST, you would expect to be able to cash out for $1 at any point, but it lost its peg,” Bumbera says. Adam Carlton, CEO of crypto wallet Pink Panda, says Tether’s history of being transparent about how the coin is backed hasn’t always been clear or consistent.

  • According to Rune Christensen, the name of the cryptocurrency is based on the Chinese character 貸, which he translated as “to lend or to provide capital for a loan”.
  • While we can’t answer that for both legal and subjective reasons – we can offer a list of the best-known stablecoins.
  • The government is trying to get a handle on the situation and keep investor confidence.
  • Besides stablecoins, the bank also trades reservecoins in order to capitalize itself and maintain a reserve ratio significantly greater than one.
  • In addition to individual and business payments, stablecoins can be used for trading, borrowing and lending, earning yield, as alternatives to banking, for sending remittances, as stores of value, and more.

For example, the reserve of a fiat-backed stablecoin like USDC may contain $1 million in U.S. dollars to serve as collateral for a million USDC. The stablecoin and reserve move in unison, so when a stablecoin holder chooses to cash out their tokens, an equal amount of the backing fiat asset is taken from the reserve and sent to the user’s bank account. The interest in stablecoins is that they are built to withstand volatility in a way that other cryptocurrencies aren’t, but still offer mobility and accessibility.

Understanding how to pay taxes on your crypto profit

Today, the total market capitalisation of all the stablecoins in the world has reached more than US$150 billion. They command over half of the global crypto trading volume, making them an important asset for the DeFi ecosystem. They are pegged to traditional assets like fiat money or gold, making them a relatively less volatile alternative than typical cryptocurrencies.

what is a stablecoin and how it works

Bridging the gap between fiat currency and cryptocurrency, stablecoins aim to achieve stable price valuation using different working mechanisms. USD Coin is a digital currency that is fully backed by U.S. dollars or dollar-denominated assets like U.S. USDC’s reserve assets are held in segregated accounts with regulated U.S. financial institutions. The accounting firm Grant Thornton oversees these segregated accounts and provides monthly attestation reports. As the name describes, commodity-backed stablecoins are pegged to the value of commodities like precious metals, industrial metals, oil or real estate.

How Do I Buy USDT?

One algorithmic stablecoin is AMPL, which its creators say is better equipped to handle shocks in demand. The other and perhaps more popular way that people use stablecoins is to participate in decentralized finance projects, such as crypto lending and borrowing platforms. Minimizing the volatility risk for users could make it easier to understand the cost that can come from these transactions.

what is a stablecoin and how it works

Crypto staking, in which cryptocurrency owners can earn rewards by essentially lending out their holdings to help execute other transactions. Staking carries risks, however, so make sure you read up on the specifics for the coin you intend to use. In October 2021, the International Organization of Securities Commissions said stablecoins should be regulated as financial market infrastructure alongside payment systems and clearinghouses. The proposed rules focus on stablecoins that are deemed systemically important by regulators, those with the potential to disrupt payment and settlement transactions. Stablecoins are more useful than more-volatile cryptocurrencies as a medium of exchange. Not all stablecoins release full public audits and many provide only regular attestations.

Tether and the TerraUSD Meltdown

Cryptocurrency users also need to be aware of the changing regulatory landscape around digital assets. In addition, Tether is a centralized cryptocurrency whereas Bitcoin is decentralized. According to Daniel Rodriguez, chief operating officer at Hill Wealth Strategies, the key difference between TetherUSD and Bitcoin is that Tether is tied to a non-crypto asset, the U.S. dollar. Bitcoin is not tied to anything beyond the supply and demand for BTC. Tether is used by investors who want to avoid the volatility typical of cryptocurrencies while holding funds within the crypto system. USD Coin is managed by Centre, a consortium co-founded by the cryptocurrency exchange Coinbase and Circle, a financial technology company.

what is a stablecoin and how it works

The safest options may be those that hold fiat currency in regulated accounts. Or some keep part of the funds in fiat currencies and invest the rest of the collateral. “There’s a bit more risk here because major price changes in those assets could threaten the ability of token-holders to cash out,” says Brody.

Live from New York and Hong Kong, bringing you the essential stories from the close of the U.S. markets to the open of trading across Asia. Commenting on the Bloomberg report, Yang said that Hope will be staked by Babel but won’t directly repay creditors. This fee will be offset by additional pledged $ADA added to the pool by Wave, that will yield increased rewards for $SHEN holders.

NNon-collateralized stablecoins rely on a mechanical algorithm which changes the supply volume as needs be in order to maintain their price. But to borrow DAI, users must lock cryptocurrency into a smart contract called a collateralized debt protocol via the MakerDAO ecosystem. Once a user locks cryptocurrency into the CDP, they will then receive an equally representative amount of DAI. When it’s time to withdraw the original collateral amount, the user must put the initial amount of DAI, plus interest, back into the smart contract.


Designed for our increasingly global economy, stablecoins theoretically solve a few key problems that inhibit the exchange of money. You can think of an algorithmic stablecoin as a bucket of water left outside with a water level marked on the inside. To keep the water inside the bucket at exactly the same level, you set up a mechanism that adds or removes water depending on how far the water level has deviated from the mark. Conversely, if it’s a hot day and water evaporates out of the bucket, the computer algorithm would instruct the mechanism to add more water to the bucket until the correct level is regained.

what is a stablecoin and how it works

At that time, TerraUSD used an algorithm-based system to maintain its peg to the dollar instead of cash reserves. The collapse of this system is widely cited as one of the main causes of the ongoing crypto winter. When you purchase $100 in Tether, you would receive approximately 100 USDT tokens and the company would boost its reserves by $100 in order to maintain the 1-to-1 dollar peg.

Is Investing in USD Coin Risky?

The minimum collateralization ratio for Ether is currently set at 150%, which means a depositor of $150 worth of Ether may borrow up to 100 Dai (worth roughly $100). If the collateralization ratio of a loan falls below the minimum ratio, anyone may call a function on the contract to liquidate the loan and receive a percentage of the collateral as a reward. Another way to avoid depegging is by improving the design of stablecoins.

As indicated by the groundbreaking crash of algorithmic stablecoin Terra, algorithmic stablecoins need sufficient demand to maintain value. And while the idea of algorithmic stablecoins has merit, there is still a lot to figure out here, so proceed with caution. If the market price of ETH drops but remains above a set threshold, the excess collateral buffers DAI’s price to maintain stability. However, if the ETH price drops below a set threshold, collateral is paid back into the smart contract to liquidate the CDP. If you’re curious about cryptocurrency, think about using some “fun money” — those dollars left over after you’ve built your savings and paid for essential expenses.

This stability makes them useful for buying goods and services or storing value without having to worry about the volatility of other cryptocurrencies. Stablecoins are usually pegged to an asset or a basket of assets that have a relatively stable value, such as the US dollar, gold, or other cryptocurrencies. The idea is that if the value of the pegged asset rises or falls, the asset’s value will rise or fall in lockstep. Stablecoins are a class of cryptocurrency that aims to provide price stability.

You may obtain access to such products and services on the App. This is a simple method but needs regular auditing and a financial custodian to oversee that the token remains fully collateralized – which presents a disadvantage of the token being centralized by a party. Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more – straight to your e-mail. We break down the different types of this emerging investment and explain its risks. All cryptocurrencies are powered by open-source code known as blockchain.