Stablecoins: What Are They, and How Do They Work?

With new cryptocurrencies and blockchain assets being minted daily, keeping tabs on them all is virtually impossible. Still, most of them have similar characteristics other than the name itself: they are known to be largely volatile blockchain-based assets.

However, there is a category of coin that is considered to be significantly less volatile than the average coin - stablecoins. The name is self-explanatory; these coins have a certain degree of stability that others do not. Keep reading to learn more about what stablecoins are and why they're useful.

Two Types of Stablecoins

There’s more than one way to achieve stability, and they can be separated into two categories: those pegged to another asset and the algorithmic ones.

Pegged Stablecoins

The pegged stablecoins have their value anchored to another asset. This can vary from coin to coin: some are pegged to fiat currencies, others to precious metals. Regardless, the total value of the specific coin in circulation is ideally backed by the denominated asset, with at least equal value.

This is how their stability is achieved. If, for instance, the value of all coins in circulation amounts to a billion dollars, the value of the asset backing the coins should be worth at least a billion dollars as well.

These coins are exempt from the usual cryptocurrency volatility but are still subject to the price variations suffered by the asset they are pegged to. Those pegged to the US Dollar, such as USD Coin (USDC), will fluctuate in tandem with the Dollar. This means that one USDC will always be worth one US dollar, regardless of what the Dollar is actually worth.

In some cases, the price of a coin can be pegged to other cryptocurrencies. The backing mechanism is the same, except that the asset is another cryptocurrency.

Algorithmic Stablecoins

The other type of stablecoin is known as algorithmic or seigniorage-style. These coins are not backed by any asset – they try to achieve stability by controlling the cryptocurrency’s supply by utilizing algorithms.

If the price is too high, more coins will be minted in an attempt to keep things balanced. The opposite is also true: if the price is too low, the algorithm will signal the purchase of some of the coins, reducing supply. This type of stablecoin is far less common than pegged ones.

Why Are Stablecoins Useful?

By eliminating the intrinsic volatility of traditional cryptocurrencies, stablecoins are much more practical from a daily usage standpoint. On top of that, they also allow for the conversion of less stable currency into a potentially more stable one.

An example of this would be if someone lives in a country with high inflation rates: they can choose to convert their assets into USDC or any other stablecoin, ensuring that their hard-earned cash doesn’t wither away due to high inflation.

Are There Downsides To Investing In Stablecoins?

Unfortunately, nothing is perfect, and no investment is 100% safe. The downsides vary from coin to coin. The most common worry is the apparent lack of decentralization compared to regular cryptocurrencies.

Another important factor is the so-called market confidence in the coin, which is usually related to the asset reserves to which the coin’s value is pegged. These reserves need to be audited to ensure that the coins aren’t being minted beyond the value of said reserves. If suspicions arise in this regard, the bad press can be harmful.

Lastly, there is also the fact that it is impossible to ensure that the stablecoin will indefinitely hold onto its stability – on a long-term basis, it might not be as stable as the fiat currency or asset to which they are pegged.

How Do You Buy Stablecoins?

If you’re looking for a way to invest in stablecoins, we offer several great options on our crypto trading platform. You can buy stablecoins in a standard trading account or save for retirement by buying stablecoins in a crypto IRA.

No matter how you buy crypto on My Digital Money, you can rest assured that your assets are secured by our military-grade security. In addition, you can feel comfortable knowing your assets are safe from liquidity issues as they’re held in a trust.

Click here to open an account on My Digital Money, or give us a call to learn more about buying stablecoins on My Digital Money.