How Are Stablecoins Pegged to Fiat Currencies?
Stablecoins are a type of cryptocurrency specifically designed to maintain a stable value by pegging them to traditional fiat currencies like the US Dollar, Euro, or Japanese Yen. The primary methods used to achieve this peg are as follows:
1. Fiat-Collateralized Stablecoins
These stablecoins are backed 1:1 by a reserve of fiat currency held in a bank account. For example, for every stablecoin issued, an equivalent amount of fiat currency is held in reserve. This ensures that holders can redeem the stablecoin for its fiat equivalent, thus maintaining its value.
2. Crypto-Collateralized Stablecoins
Instead of fiat currency, these stablecoins are backed by other cryptocurrencies. They are over-collateralized to account for the volatility of the crypto assets backing them. For instance, if a stablecoin is pegged to a dollar, $150 worth of cryptocurrencies might be locked up as collateral to issue $100 in stablecoins.
3. Algorithmic Stablecoins
Algorithmic stablecoins utilize smart contracts and algorithms to control the supply of the stablecoin. Instead of being backed by reserves, they dynamically adjust the supply based on market demand. This method aims to stabilize the price through incentivizing users to buy or sell the stablecoin based on its market price.
In conclusion, stablecoins maintain their peg to fiat currencies using various mechanisms, including collateralization and algorithmic adjustments, providing an essential bridge between traditional finance and the crypto world.