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How stablecoin prices stay stable?

What is stablecoin?

Stablecoins are cryptocurrencies that use various methods to keep their value stable.

Stablecoins are cryptocurrencies designed to take advantage of the price stability of (strong) fiat currencies while maintaining the security, speed and low cost of virtual asset transactions. It was originally developed for minimizing price volatility in the trading of cryptocurrencies, making everyday spending and building bridges with financial institutions. They are now starting to tap into mainstream banking apps to ease the cost and burden of making payments.

There are four main types of stablecoins. The first three models; create stablecoins backed by fiat currencies, commodities or other cryptocurrencies. The fourth option is decentralized stablecoins, which automatically rely on algorithms and smart contracts to maintain their value.

Are stablecoins controversial?

While bankers and executives see stablecoins as useful tools, regulators are wary of the potential for some tokens to compete with national currencies.

The answer depends on how it is used and who is using it. In June 2019, Facebook launched the stablecoin project called Libra and changed its name to Diem to disperse the dark clouds above it. The idea was to create a national currency-backed stablecoin that 2.3 billion members of the social media network can use to make payments.

The authorities, who moved away from being cautious about the project, which made a big splash in a few days, rolled up their sleeves for strict regulations. Central banks, regulators and international financial institutions around the world have described Libra as a threat to national sovereignty and the stability of global finance. Rumors of financial apocalypse and angry statements followed. Everything was done to cancel the project. Despite major obstacles, the project continues.

On the other hand, in January 2021, US acting currency controller Brian Brooks authorized banks to use stablecoin networks by running nodes to facilitate payments, while the EU worked on a broader cryptocurrency regulatory framework and created a specific issue on stablecoins. published the guide.

That is, a stablecoin led by an untrusted and dominant social media network that appears to be trying to create a global stablecoin with the ability to destroy and undermine national currencies? Or are they stablecoins used by banks that don't want to transform the current financial order?

What is a fiat backed stablecoin?

The fiat-backed stablecoin keeps the price stable by storing fiat currency that supports each coin one-to-one.

The first and simplest stablecoin models; especially the US dollar, euro, yen and similar currencies were implemented at a one-to-one ratio. As long as the base currency (or the basket of currencies Libra originally proposed) remains stable, the stablecoin will hold its value. Essentially, they are backed by the "full faith and credibility" of the fiat issuer, a value defended by that country's central bank.

The largest of these was Tether, which at the time of this writing has a market cap of $62.2 billion. But other leading stablecoins include Circle and Coinbase's USD Coin ($23 billion), Binance USD ($9.6 billion), and DAI ($4.8 billion).

Tether claimed to be backed by 100 percent US dollars from day one on a one-to-one basis. After the New York Attorney General sued Tether, it was revealed that 26 percent of the amount was an IOU from its sister company, Bitfinex exchange. Tether recently announced that its "cash reserves" include around 3 percent cash.

What is an asset-backed stablecoin?

The asset-backed stablecoin is similar to the fiat-backed model, but is based on physical assets such as gold.

Commodity-backed stablecoins are backed by a variety of tangible collateral, notably gold, the traditional store of value, rather than fiat currencies. They can also be backed by baskets of precious metals or even Swiss real estate. Generally, these stablecoins are linked to a certain amount of commodities and are stored in an official location. They are often subject to inspections. Tether, the fiat stablecoin, has long avoided these audits.

Pax Gold, an ERC-20 token created by Paxos CEO Charles Cascarilla, is backed by one ounce of London Good Delivery gold stored in Brinks' LBMA-approved gold vault in the UK capital. It can be used for precious metal. Digix Gold, on the other hand, is 99.99 percent pure gold per gram, which is stored in Singapore and inspected quarterly.

What is an algorithmic stablecoin?

More complex than others, these stablecoins maintain price stability by increasing or decreasing supply, using their market power to keep their value stable. For this, they use algorithms and smart contracts.

The most complex version of stablecoins are algorithmic stablecoins that are not backed by any collateral. As the name suggests, its value is controlled by special algorithms and smart contracts that automatically reduce or increase the token supply in the market to keep the price of the token stable with the fiat currency it is tracking. Algorithms remove the tokens from circulation as soon as the market price begins to fall below the dollar, euro, or whatever asset it is based on. If the stablecoin's value rises above fiat, the system will add new stablecoins to the market.

So the goal is essentially to create a decentralized and automated central bank that increases or decreases the stablecoin supply to maintain the price level.

What is a crypto-backed stablecoin?

Crypto-backed stablecoins use over-collateralized loans to keep their value stable.

Crypto-collateralized stablecoins consist of baskets containing one or more cryptocurrencies. Because these have highly volatile prices, they are highly collateralized and require buyers to lock their collateral tokens into smart contracts that will be liquidated if the value of the collateral drops too much. A collateral that can be collected by exchanging stablecoins…

One of the best-known crypto-backed stablecoins is MakerDAO's DAI, which is pegged to $1. However, rest assured that it is vital that the system can handle extreme conditions, as MakerDAO learned at its "black swan" event on March 12, 2020, when the value of ETH was halved in less than 24 hours after being overwhelmed by liquidations. implement significant governance and auction management changes. This has been successful, and at this writing, the stablecoin has a market cap of more than $4.8 billion.

But MakerDAO learned a big lesson with its "black swan" event on March 12, 2020. After massive liquidations, the value of ETH had halved in less than 24 hours, making it imperative to implement governance and auction management changes as it is vital to ensure the system can handle extreme conditions.


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