A stablecoin is a type of cryptocurrency that is designed to maintain a stable value, rather than experiencing significant price changes. Recently, these digital currencies have grown substantially in popularity as an answer to the high volatility associated with the cryptocurrency markets.
Although the exact mechanisms vary from one coin to another, stablecoins are supposed to have their values fixed by pegging them to the price of another asset. Although most of them are pegged to the US dollar, there are stablecoins pegged to the price of 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 dollars or gold). So they issue new units based on the value of their holdings. This model is the basis of Tether (USDT), which is currently one of the most used and well-known stablecoin. Therefore, Tether company is supposed to hold $1 US dollar for each unit of USDT issued, and they should only issue new USDT tokens when the equivalent value is received 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.
Non-collateralized coins, 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. In most cases, the goal of these coins is to maintain a price point at or near US$1.00.
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, decentralization, and privacy. Moreover, when compared to traditional fiat currencies, they present faster transactions and lower fees - making them quite useful for both international and everyday payments.