For example, MakerDAO’s Dai (DAI) stablecoin is pegged to the U.S. dollar but backed by Ethereum (ETH) and other cryptocurrencies worth 150% of the DAI stablecoin in circulation. Crypto-collateralized stablecoins are backed by other cryptocurrencies. Because the reserve cryptocurrency may also be prone to high volatility, such stablecoins are overcollateralized—that is, the value of cryptocurrency held in reserves exceeds the value of the stablecoins issued.
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These other assets may act like actual cash much of the time, but they’re not real cash. Many or all of the products featured here are from our partners who compensate us. This influences which products we write about and where and how the product appears on a page. Counterparty risk is the probability that the other party in the asset may not fulfill part of the deal and default on the contractual obligation. Skylar Clarine is a fact-checker and expert in personal finance with a range of experience including veterinary technology and film studies.
Reserve-backed stablecoins
Cryptocurrency-backed stablecoins are issued with cryptocurrencies as collateral, conceptually similar to fiat-backed stablecoins. In many cases, these allow users to take out a loan against a smart contract via locking up collateral, making it more worthwhile to pay off their debt should the stablecoin ever decrease in value. In addition, to prevent sudden crashes, a user who takes out a loan may be liquidated by the smart contract should their collateral decrease too close to the value of their withdrawal. Because the backing asset can be volatile, crypto-backed stablecoins are overcollateralized to ensure the stablecoin’s value.
Why Are Stablecoins So Important?
Stablecoins are cryptocurrencies that claim to be backed by fiat currencies—dollars, pounds, shekels, rubles, etc. The investing information provided on this page is for educational purposes only. NerdWallet, Inc. does not offer advisory or brokerage services, nor does it recommend or advise investors to buy or sell particular stocks, securities or other investments. This may influence which products we review and write about (and where those products appear on the site), but it in no way affects our recommendations or advice, which are grounded in thousands of hours of research. Our partners cannot pay us to guarantee favorable reviews of their products or services. “While investing their dollar reserves can increase profits, it also increases the risk of a (bank) run, and not having sufficient liquid reserves to meet redemptions in response to an investor panic,” Natraj says.
- Skylar Clarine is a fact-checker and expert in personal finance with a range of experience including veterinary technology and film studies.
- A stablecoin is a cryptocurrency whose value is pegged to the price of another asset, hence the term “stable.” For example, if functioning correctly a stablecoin pegged to the U.S. dollar should always be valued at $1.
- Due to the highly volatile and convergent cryptocurrency market, substantial collateral must also be maintained to ensure stability.
- In some ways that’s not so different from central banks, which also don’t rely on a reserve asset to keep the value of the currency they issue stable.
- To serve as a medium of exchange, a currency that’s not legal tender must remain relatively stable, assuring those who accept it that it will retain purchasing power in the short term.
Unlike other cryptos, with value that can fluctuate wildly, fiat-backed stablecoins aim to have very small price fluctuations. But that’s not to say stablecoins are a totally safe bet — they are still relatively new with a limited track record and unknown risks, and should be invested in with caution. The cryptocurrency exchange Coinbase offers a fiat-backed stablecoin called USD coin, which can be exchanged on a 1-to-1 ratio for one U.S. dollar. Stablecoins are typically pegged to a currency or a commodity like gold, and they use different mechanisms to maintain their price peg.
Fiat-backed stablecoins can be traded on exchanges and are redeemable from the issuer. The stability of the stablecoin is equivalent to the cost of maintaining the backing reserve and the cost of legal compliance, licenses, auditors, and the business infrastructure required by the regulator. Binance USD (BUSD) is the third largest stablecoin by market cap and is pegged to the dollar on a one-to-one basis. According to its partner developers, Binance and Paxos, BUSD is 100% backed by an “equal amount” of U.S. dollars and treasury bills. Tether (USDT) is the world’s first stablecoin, the largest in terms of market capitalization, and the most transacted stablecoin in the market.
And regulators are warming up to them, too; in September 2020, the US Office of the Comptroller of the Currency (OCC) gave national banks and federal savings associations the green light to hold reserves for stablecoin issuers. The idea is that, unlike cryptocurrencies like Bitcoin, stablecoins’ prices remain steady, in accordance with whichever fiat currency backs them. The theory goes, if you create a nvidia titan v cryptomining performance does not disappoint but price/perfomance factor is way off currency that is ‘pegged’ or attached to a regular fiat currency like the US dollar or something else with a relatively stable price, it will prevent price swings. Precious metal-backed stablecoins use gold and other precious metals to help maintain their value. These stablecoins are centralized, which parts of the crypto community may see as a drawback, but it also protects them from crypto volatility.
For example, a $1 crypto-backed stablecoin may be tied to an underlying crypto asset worth $2, so if the underlying crypto loses value, the stablecoin has a built-in cushion and can remain at $1. These assets are less stable than fiat-backed stablecoins, and it is a good idea to keep tabs on how the underlying crypto asset behind your stablecoin is performing. One crypto-backed stablecoin is dai, which is pegged to the U.S. dollar and runs on the Ethereum blockchain. Such reserves are maintained by independent custodians and are regularly audited.
For example, traders might convert Bitcoin into a stablecoin such as Tether, rather than into dollars. Stablecoins are available 24/7, making them more accessible than cash obtained through the banking system, which is closed overnight and on weekends. Impact on your credit may vary, as credit scores are independently determined by credit bureaus based on a number of factors including the financial decisions you make with other financial services organizations. Stablecoins are cryptocurrencies whose values are tied to those of real-word assets such as the U.S. dollar. They were developed in part as a response to the price volatility experienced by traditional cryptocurrencies such as Bitcoin, whose utility as a form of payment is limited by rapid changes in market value.
Stablecoins are a type of Bitcoin alternative (altcoin) that is built to offer more stability than other cryptos. Some are actually backed by a reserve of the asset they represent; others use algorithms or other methods to keep their values from fluctuating too much. But due to the underlying collateral being in cryptocurrency, it is prone to more volatility. Stablecoins are not recognized as “legal tender” in most countries. Even if a stablecoin’s monetary value is pegged to a given currency, it may not be recognized as a legitimate form of payment by government or commercial entities.
The complexity and non-direct backing of the stablecoin may deter usage, as it may take time to comprehend how the price is ensured. Due to the highly volatile and convergent cryptocurrency market, substantial collateral must also be maintained to ensure stability. They seek to provide fiat value and price stability in a blockchain environment where digitized (yet non-decentralized) cash may not be recognized. Although all stablecoins aim to maintain a pegged ratio to a given fiat currency, the assets they hold as collateral may determine the stability of their respective pegs. The interest in stablecoins is that they are built to withstand volatility in a way that other cryptocurrencies aren’t, but still offer mobility and accessibility.
In Tether’s case, this has never been conclusively provided, sparking rumors that the currency was unbacked and was in fact minted out of thin air. Each CACHE is backed by 1g of pure gold held in the vaults stored around the world. Sending CACHE tokens is the equivalent of sending 1g of https://cryptolisting.org/ gold per token since they can be easily redeemed for physical gold at any time. Meanwhile, stablecoins have been facing a high level of regulatory uncertainty. In November of 2021, a report prepared by the Biden administration called for additional government oversight of stablecoins.
