What are stablecoins and how do they work?

Each CACHE is backed by 1g of pure gold held in the vaults stored around the world. Sending CACHE tokens is the equivalent of sending 1g of gold per token since they can be easily redeemed for physical gold at any time. Meanwhile, stablecoins have been facing a high level of regulatory uncertainty. In November of 2021, a report prepared by the Biden administration called for additional government oversight of stablecoins.

Money, payments and spending

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At their core, stablecoins are cryptocurrencies that try to maintain a “peg”—the same market value as the external asset they represent. For example, a dollar-based stablecoin will aim to stay pegged to $1, while a gold stablecoin aims to stay pegged to the market price of gold. The stablecoin issuer ensures stability of their cryptocurrency by keeping fiat currency as collateral with a financial institution. The stablecoin always has a set amount of fiat currency in reserve that’s proportionate to cryptocurrency wallet guide for beginners 2021 the stablecoins it has issued.

Of these, gold is generally the most popular commodity used as collateral for commodity-backed stablecoins. Experts say the DAI stablecoin is overcollateralized, which means that the value of cryptocurrency assets held in reserves might be greater than the number of DAI stablecoins issued. Fiat currencies, such as the U.S. dollar or the British pound, don’t see this level of price volatility. So another way to think about stablecoins is as a tokenized version of a fiat currency. In theory, a U.S. dollar-based stablecoin is a token that will reside on a blockchain and always trade for one dollar. Such reserves are maintained by independent custodians and are regularly audited, something that should be considered cautiously.

Another type of digital asset similar to centralized stablecoins are central bank digital currencies (CBDCs). CBDCs are similar to centralized stablecoins, but they are issued by central banks and thus don’t necessarily have to be backed by fiat money in an off-chain bank account. CBDCs are considered legal tender by the government that issues them and are used for streamlining payments between both individuals and institutions. For stablecoin protocols that utilize off-chain reserves, recurring audits enabled by Chainlink PoR help enhance transparency and ensure the status of the reserves backing a stablecoin. Stablecoins that use PoR can offer a higher degree of transparency to their users as they can prove that their tokens are backed.

Types of Stablecoins

Like most digital assets, stablecoins are primarily used as a store of value and as a medium of exchange. They give traders temporary reprieve from volatility when the market is tumbling, and can also be used in the rapidly growing world of decentralized finance (DeFi) for things like yield-farming, lending, and liquidity provision. Crypto-collateralized stablecoins are backed by other cryptocurrencies. Because the reserve cryptocurrency may also be prone to high volatility, such stablecoins are generally overcollateralized—that is, the value of cryptocurrency held in reserves exceeds the value of the stablecoins issued. To buy stablecoins you’ll need an account with a crypto exchange or a digital wallet where you can buy crypto directly.

For instance, in November 2021, Senator Cynthia Lummis (R-Wyoming) called for regular audits of stablecoin issuers, while others back bank-like regulations for the sector. In 2024, Senators Lummis and Kirsten Gillibrand introduced a bill to create a regulatory framework for stablecoins. Their proposed framework would prohibit anyone from issuing a stablecoin unless they were a registered non-depository trust or a depository institution with authorization to issue them. Stablecoins continue to come under scrutiny by regulators, given the rapid growth of the $162 billion market and its potential to affect the broader financial system. In October 2021, the International Organization of Securities Commissions (IOSCO) said stablecoins should be regulated as financial market infrastructure alongside payment systems and clearinghouses. Its proposed rules focus on stablecoins that are deemed systemically important by regulators, those with the potential to disrupt payment and settlement transactions.

How does a stablecoin work?

These stablecoin designs typically require trust in the custodian, although Chainlink Proof of Reserve can provide strong transparency guarantees through automated verification. The interest in stablecoins is that they are built to withstand volatility in a way that bitcoin sv undergoes first halving a day after bch other cryptocurrencies aren’t, but still offer mobility and accessibility. A more stable cryptocurrency is still decentralized, meaning it isn’t beholden to the rules and regulations of a centralized system. That provides an entrypoint into the world of DeFi, with possibilities including faster money transfers, access to financial services without applications, keeping financial data private and avoiding financial service fees. Centralized stablecoins provide a digital option with the backing of a traditional currency.

1. Algorithmic stablecoin issuers can’t fall back on such advantages in a crisis.
2. Fiat-backed stablecoins are the cryptocurrencies most closely related to fiat (or traditional) currencies because they are backed by real-world currencies.
3. USDC is a stablecoin outlier in disclosing precise data regarding its assets and liabilities.
4. They are both new forms of digital money that have the potential to be used to pay for things.

Decentralized stablecoins that employ an overcollateralized design also require a blockchain price oracle to help trigger liquidations and ensure protocol solvency. For example, LUSD is an immutable DeFi protocol that enables users to lock up their ETH at a 110% over-collateralization ratio to mint the LUSD stablecoin. The protocol is underpinned by Chainlink Price Feeds, which help provide accurate and high-quality price data that the LUSD smart contract uses to automatically trigger liquidations. While cryptocurrencies are often known for their volatility, stablecoins bring relative stability to cryptocurrency markets by allowing fiat currencies like the U.S. dollar to be represented on the blockchain as digital tokens. These stablecoins allow anyone around the world to hold a token that’s purposely designed to hold its value in relation to the fiat currency it claims to represent (e.g. 1 USD stablecoin tries to maintain a value of 1 U.S. dollar).