Stablecoins Explained: Can a Cryptocurrency Actually Be Stable?

We've all heard the perks of Bitcoin touted far and wide by tech bros and crypto nerds. It's decentralized, it's secure, it's private. If you invest in crypto wisely, your wealth can skyrocket—but you can also lose a lot. What scares many consumers and businesses alike away from cryptocurrency, in general, is its volatility—Bitcoin can lose thousands of dollars in value in a single day.

What if there were a kind of cryptocurrency that offered all the perks of privacy and decentralization without all the volatility? Stablecoins, explained simply, attempt to do just that. Here's how stablecoins manage to achieve relative stability in the wild world of cryptocurrency.

A stablecoin is a type of cryptocurrency that's designed to have its value track that of an external asset. Stablecoins are usually pegged to the value of real currency (such as the US dollar), other cryptocurrencies, or a commodity (such as gold). 

Some stablecoins are physically backed by the asset they track, similar to how real currency used to be backed by gold. This means that the issuer of the stablecoin holds a reserve of the asset its value tracks. Other stablecoins are pegged to an external asset through a process of buying and selling that asset to stabilize prices.

Stablecoins were created to offer price stability in an asset (cryptocurrency) that's usually wildly volatile—Bitcoin and Ethereum are not stablecoins, which is why their value experiences such dramatic gains and losses. In addition to offering a more stable valuation, like some real currencies do, stablecoins offer the unique benefits of cryptocurrency: privacy, security, and ease of transactions.

This joining of the benefits of cryptocurrency and real currency has financial experts and economists positing that stablecoins may play a large part in the global economy going forward. They offer consumers the relative stability they expect from currency while also providing a framework for creating faster, low-cost, transparent, and generally more efficient transactions. Stablecoins are also borderless and highly adaptable. Since they're programmable, new and unique features can be added by issuers to create a currency that better fits their needs.

There are four different types of stablecoins, each categorized by the asset that collateralizes it: fiat-backed, cryptocurrency-backed, commodity-backed, and algorithmic.

The most popular stablecoins are fiat-backed, and usually, they're backed by the US dollar (USD). There are also stablecoins pegged to the euro, the great British pound, and the Japanese yen. Usually, fiat-backed stablecoins are fixed at a 1:1 ratio—so one stablecoin might be equal to $1 USD, for example. This makes fiat-backed stablecoins fairly stable and very easy to understand, but having a peg to a fiat currency means they're more centralized and prone to additional regulations.

Examples of fiat-backed stablecoins

Tether (USDT) is the most popular stablecoin, having surpassed even Bitcoin in trading volume back in 2019. It's pegged to USD at a 1:1 ratio, so one Tether is always worth $1.00.

Cryptocurrency-backed stablecoins are pegged to the value of an external cryptocurrency. This might sound a little solipsistic, but these stablecoins are usually overcollateralized in order to ease any price volatility in the coin they're pegged to. For example, an issuer may require $1,000 in Ether reserves to back $500 worth of an Ether-backed stablecoin. While crypto-backed stablecoins aren't quite as stable and easy as fiat-backed, they offer a much greater degree of decentralization, which is one of the main draws of using cryptocurrency in the first place.

Examples of crypto-backed stablecoins

Wrapped Bitcoin (WBTC) is one of the most popular crypto-backed stablecoins. It's pegged to the value of Bitcoin at a 1:1 ratio, but unlike Bitcoin, it trades on the Ethereum blockchain which gives it more liquidity and utility.

Commodity-backed stablecoins can be pegged to the value of any commodity, such as precious metals, oil, or real estate, although the most common commodity used as collateral is gold. Being backed by reserves of real assets such as gold gives commodity-backed stablecoins one big advantage: value appreciation. As these commodities go up in value, so do the stablecoins that are pegged to them. This can be a big draw for some cryptocurrency investors, as it gives them an opportunity to essentially invest in the underlying commodity without all the costly logistical requirements of acquiring and storing an asset like gold.

Examples of commodity-backed stablecoins

Tether Gold (XAUT) is one of the most popular gold-backed cryptocurencies. Launched in 2020 by the issuers of Tether (USDT), Tether Gold is backed by a reserve of gold bars stored in a Swiss vault, with one Tether Gold being equal to one ounce of gold in value.

Algorithmic stablecoins are actually not backed by any other currency or commodity. Instead, issuers of algorithmic stablecoins ease price volatility in their stablecoins by using algorithms to control supply. When demand for an algorithmic stablecoin rises, more coins are released to keep the price at its peg. If demand drops, issuers buy up the stablecoin to keep the price from falling significantly below its peg. This isn't too dissimilar from how fiat currency is controlled by central banks. While this makes them more prone to crashing and less liquid, algorithmic stablecoins are the most decentralized of the bunch.

Examples of algorithmic stablecoins

DeFi Dollar (DFD) is one of the more popular algorithmic stablecoins. Touting itself as the "future of stablecoins," this cryptocurrency loosely tracks the value of the dollar but isn't backed by anything.

You can buy stablecoins on many major crypto exchanges, the same way you'd buy Ethereum or Bitcoin. You'll need to open an account with a crypto exchange if you don't already have one, and you'll also need a digital wallet.

Coinbase is one of the most popular crypto exchanges, and they support the USDC stablecoin, a popular stablecoin backed by the USD. Coinbase also supports Tether and Wrapped Bitcoin. Coinbase Pro is even planning to launch a Japanese yen-pegged stablecoin called GYEN.