Most of the cryptocurrencies were created with the purpose of being a medium of exchange and not simply a store of value. The problem is that due to their smalls market caps, even the most popular cryptocurrencies tend to experience too much price fluctuation. However, do you know what a stablecoin is?
Typically, the smaller the Market Cap of an asset, the more volatile its price will be.
Imagine throwing a rock into a small pond. Now take the same rock and drop it into the ocean.
Right now, the Market Cap for cryptocurrencies is like a little pond and every stone that falls creates a lot of fluctuation in the price.
Imagine how difficult it is to use Bitcoin or any other cryptocurrency for daily transactions and to trade if one day it is worth X and the next day it is worth half of X.
For that same reason, It is important that you know what a stablecoin is, what the types are and how they work.
The purpose of stablecoins is to create a cryptocurrency that is not volatile. The value of a stablecoin is tied to a real world currency, also known as FIAT money. For example, stablecoin Tether (USDT) or stablecoin DAI are worth 1 dollar and are expected to have that value no matter what.
Since few people really knows what a stablecoin is, they have low acceptance as a payment method and for this reason, the main use of stablecoins is for trading purposes on different exchanges.
When traders want to minimize risk they can choose to trade volatile cryptocurrencies (like Bitcoin or Ethereum) for stablecoins.
For example, if you invest in Bitcoin and the value starts to drop against the dollar, you can simply trade your BTC for the stablecoin Tether (USDT) or DAI and keep the dollar value in seconds.
So, when you want to trade again, because you expect that Bitcoin will rise, you just have to change your Tether or DAI for Bitcoin again.
You may wonder how a stablecoin keep its price stable. There are different ways to do it:
Stablecoins backed by FIAT
One way to maintain parity with the FIAT currency is by building trust in the company behind it. For this reason, companies like DAI or Tether support their stablecoins with dollars and undergo constant audits that guarantee and certify that there is a dollar behind each cryptocurrency issued.
If the market doesn’t believe that a Tether is worth a dollar, people would simply sell their USDT and the price would drop immediately.
Stablecoins backed by Cryptocurrencies
Another way to maintain parity is by linking the stablecoin to one or more cryptocurrencies. This option is much simpler to audit since the company’s balance can be seen on the blockchain.
In the following chart you can find some of the most popular stablecoins, classified according to their support.
By following a few simple steps you will receive stablecoins in your cryptocurrency wallet.
In short, remember that a stablecoin is a type of cryptocurrency that is tied to the price of a less volatile asset, for example, the dollar.
If you want to learn more about the crypto world you can find many interesting articles by browsing our blog.