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Stablecoins 101: A Beginner's Guide

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Stablecoins have been gaining momentum in the world of cryptocurrency as a new and emerging asset class. They offer a unique value proposition by maintaining a stable value relative to a reference asset, such as the US dollar, while still providing the benefits of fast, cheap transactions and censorship resistance that traditional cryptocurrencies like Bitcoin offer. In this two-part series, we will take a comprehensive look at the basics of stablecoins, the different types available, how they work and the potential advantages and disadvantages of investing in them. By the end of this series, you will have a better understanding of this growing asset class and how to approach them as a potential investment opportunity.

What are stablecoins?

A Stablecoin is a type of digital asset that aims to maintain a stable value relative to a reference asset, such as the US dollar. They are often pegged 1:1 with the underlying asset, meaning that one stablecoin is equivalent to a certain amount of the reference asset. The primary objective of stablecoins is to provide the benefits of traditional cryptocurrencies such as fast and low-cost transactions and censorship resistance while also ensuring price stability, making them a popular choice for investors who wish to avoid the volatility seen in other cryptocurrencies.

Types of stablecoins:

When it comes to stablecoins, there are a variety of options available each with their own unique features and properties. Some of the most popular include:

Fiat-Pegged Stablecoins: These stablecoins are directly tied to a fiat currency like the US dollar or Euro. They are generally issued and backed by a centralized institution such as a bank or financial organization. Examples include Tether (USDT) and USDC.

Crypto-Backed Stablecoins: These stablecoins are supported by other cryptocurrencies, such as Bitcoin or Ethereum. They are often over-collateralized, meaning that the value of the underlying crypto assets is greater than the value of the stablecoins issued. Examples include MakerDAO (DAI) and Havven (HAV).

Algorithmically-Stabilized Stablecoins: These stablecoins are not based on any specific assets, instead, they rely on algorithmic mechanisms to maintain their value. They may use a combination of smart contracts, collateralization, and/or buy and burn mechanisms to keep their price stable. Examples include Basis and Carbon.

How do stablecoins work?

Stablecoins use different mechanisms to maintain their value depending on the type of stablecoin. Here are some common approaches:

Collateralization : Many stablecoins, especially those that are crypto-backed or algorithmically-stabilized, use collateralization to keep their value stable. This means that the issuer holds an underlying asset such as a fiat currency or cryptocurrency as collateral to back the stablecoin. If the value of the stablecoin starts to deviate from the reference asset, the issuer can buy or sell the collateral to bring the price back into alignment.

Smart Contract: Some algorithmically-stabilized stablecoins use smart contracts to automatically maintain the stablecoin's value. For instance, a smart contract might automatically buy or sell the stablecoin on an exchange if its price starts to stray too far from the reference asset.

Buy and Burn: Some stablecoins, particularly those that are algorithmically-stabilized, use a buy and burn mechanism to maintain their value. This means that the issuer will buy back stablecoins from the market if their price starts to rise, and burn (destroy) them to reduce the supply and bring the price back down. Conversely, if the price falls too low, the issuer may issue new stablecoins and sell them to bring the price back up.

It's important to note that these mechanisms are not mutually exclusive, and depending on the type of stablecoin, different mechanisms may be used in combination to maintain its value.

Advantages and disadvantages of stablecoins:

While stablecoins offer many benefits, they also come with their own set of potential drawbacks.


Price Stability: The main advantage of stablecoins is that they maintain a stable value relative to the reference asset they are pegged to. This makes them a good option for those looking to hold onto their digital assets for the long-term without worrying about drastic price fluctuations.

Benefits of Cryptocurrency: Stablecoins also offer the benefits of traditional cryptocurrencies, such as fast and low-cost transactions, and censorship resistance, making them an attractive option for businesses and individuals looking to use digital assets for everyday transactions.

Lower Volatility: Stablecoins, as the name suggests, are less volatile in nature as compared to other cryptocurrencies. This makes it a preferred option for investors who want to hedge against the volatility seen in other digital assets.


Centralized Nature: Many stablecoins are issued and backed by centralized entities, which raises concerns about trust and security.

Overcollateralization: Many stablecoins are overcollateralized, which may not be sustainable in the long-term.

Dependency on the reference asset: The value of stablecoins is dependent on the reference asset they are pegged to and any changes in the value of that asset can affect the value of the stablecoin.

Overall, stablecoins offer a unique combination of price stability and the benefits of traditional cryptocurrencies. However, it's important to thoroughly research and understand the specific stablecoin you are considering before making any investment.


Stablecoins: Definition, How They Work, and Types?

Stablecoins’ role in crypto and beyond: functions, risks and policy

An Introduction To Stablecoins

Disclaimer: This post is for educational purposes only, the authors do not endorse or promote any products discussed herein.