A stablecoin is a type of cryptocurrency that is designed to maintain a stable market price. Recently, this type of digital currencies has grown in popularity, and we now have numerous stablecoin projects.
Although the exact mechanisms vary from one coin to another, stablecoins are supposed to be somewhat resistant to market volatility, so they should not experience significant price changes.
Many stablecoins have their values fixed by pegging them to the price of another asset. While most of them are pegged to the US dollar, there are stablecoins pegged to the price of other cryptocurrencies, or even commodities, like silver or gold. By being pegged to real-world assets, these coins avoid the wild price swings caused by the high levels of volatility, very common in cryptocurrency markets.
Collateralized vs. non-collateralized stablecoins
Collateralized stablecoin companies are expected to actually hold the assets against which their coin is pegged (e.g., US dollar or gold). So they issue new units based on the value of their holdings. This model is the basis of most stablecoins. Prominent examples include USD Coin (USDC), Paxos (PAX), and TrueUSD (TUSD), where each token is backed on a 1:1 ratio by money held in the bank accounts. So these companies only issue new stablecoin units when they receive the equivalent value in fiat currency.
Some stablecoins are pegged to other cryptocurrencies instead of fiat or commodities, and these are often referred to as crypto-collateralized stablecoins. The peg of these coins is maintained through over-collateralization and stability mechanisms. A prominent example is DAI, the stablecoin minted in the Maker DAO ecosystem.
Non-collateralized stablecoins, on the other hand, make use of algorithms to control the supply of tokens in order to keep the price fixed at a predetermined level. The goal of these coins is to maintain a stable value by algorithmically expanding and contracting its circulating supply in response to market behavior.
The idea behind stablecoins is to provide some of the advantages of both fiat and cryptocurrency worlds. Currently, stablecoins are mostly used as a hedge against the high volatility of cryptocurrency markets, but depending on the context, they can also be used as a stable currency that provides increased transparency and decentralization. Also, when compared to traditional fiat currencies, they present faster transactions and lower fees - making them quite useful for everyday payments and international transfers.