What are Stablecoins?
Stablecoins are a type of cryptocurrency designed to maintain a stable value by pegging their market price to a reserve of assets, typically fiat currencies like the US Dollar or other commodities like gold. This stability makes them an appealing option for users and investors looking to mitigate the volatility commonly associated with cryptocurrencies such as Bitcoin or Ethereum.
Types of Stablecoins
- Fiat-Collateralized Stablecoins: These are backed by a reserve of fiat currency held in a bank account. For example, Tether (USDT) is pegged to the US Dollar, meaning for every USDT issued, there is a corresponding US Dollar in reserve.
- Crypto-Collateralized Stablecoins: These are backed by other cryptocurrencies, usually over-collateralized to account for price fluctuations. MakerDAO's DAI is an example, as it uses Ethereum-based assets as collateral.
- Algorithmic Stablecoins: These do not rely on collateral but instead use algorithms to control the supply of the coin to maintain its price stability. An example includes Terra (LUNA) at its peak, which relied on an algorithmic approach.
Use Cases in DeFi
Stablecoins play a crucial role in the DeFi ecosystem, serving as the primary medium of exchange for many decentralized applications (DApps). They enable users to trade, lend, and borrow without the high volatility that accompanies traditional cryptocurrencies, facilitating a more predictable and efficient financial ecosystem.