Stablecoin Guide: Collateralized and Uncollateralized

A stablecoin, also known as a stabilcoin, is a type of cryptocurrency designed to provide price stability in the notoriously volatile cryptocurrency markets. The popularity of stablecoins is growing day by day.

Stablecoins are expected to be resistant to sudden price movements. Therefore, the value of these cryptocurrencies is usually pegged to a physical asset. The physical asset that most stablecoins are pegged to is the US dollar. Among the most well-known USD-pegged stablecoins is undoubtedly Tether (USDT). However, there are also stablecoins pegged to other cryptocurrencies or commodities like physical gold and silver. For example, PAXGold (PAXG) is a stablecoin pegged to physical gold. These stablecoins can be easily bought and sold on cryptocurrency exchanges in exchange for fiat currency.

Stablecoins pegged to reserve assets like the US dollar or gold also serve as a bridge between cryptocurrencies and everyday fiat currencies. Since stablecoins have much lower price volatility compared to cryptocurrencies like Bitcoin (BTC) or Ethereum (ETH), these cryptocurrencies can be used as a medium of exchange on exchanges.

Types of Stablecoins

Stablecoins are divided into two categories: collateralized stablecoins and non-collateralized stablecoins.

What is a Collateralized Stablecoin?

Collateralized stablecoins are stablecoins where the assets they are pegged to are held by the company. In other words, a company issuing collateralized stablecoins is expected to hold an equivalent amount of the physical asset that the cryptocurrency is pegged to. For example, PAXGold (PAXG) is such a stablecoin. This means the Paxos company holds physical gold equivalent to the amount of PAXG tokens in circulation.

There are also stablecoins pegged to cryptocurrencies. Companies issuing these may hold an equivalent amount of the relevant cryptocurrency. These types of stablecoins are called crypto-collateralized stablecoins.

Many stablecoins operate on the collateralized stablecoin model.

What is a Non-Collateralized Stablecoin?

Non-collateralized or uncollateralized stablecoins use algorithms that control token supply to maintain price at a certain level. These types of stablecoins are also known as algorithmic stablecoins. Non-collateralized stablecoins don't use any reserves.

What are Stablecoins Used For?

Cryptocurrencies like Bitcoin (BTC) and Ethereum (ETH) can be extremely volatile. Their prices can fluctuate by thousands of dollars within minutes at times. This has created a need for cryptocurrencies that won't be affected by market fluctuations or will be minimally affected. Stablecoins meet the need for price-stable assets in cryptocurrency markets. Of course, these cryptocurrencies have many different use cases.

In this section, we'll look at the leading use cases for stablecoins.

Safe Haven Asset

Stablecoins are designed to maintain stable values at all times. This feature makes stablecoins an ideal safe haven asset. Unlike cryptocurrencies like Bitcoin whose price can fluctuate significantly every day, the risk of loss in stablecoins is minimal. Moreover, since stablecoins are part of blockchain technology, they are decentralized. This means they cannot be confiscated.

Trading

You can store or transfer stablecoins in your cryptocurrency wallets and easily buy and sell them through cryptocurrency exchanges. Stablecoins can be easily sent anywhere in the world, including places where obtaining US dollars or other reserve assets may be difficult or where the local currency is unstable. This allows them to be used instead of the physical assets they are pegged to. For example, let's say you want to buy Bitcoin (BTC) with US dollars on a cryptocurrency exchange. However, obtaining US dollars in your country is prohibited or difficult for various reasons. In this case, you can buy Tether (USDT), which is pegged to the US dollar, with your local currency and trade with it.

Payments

Recently, Walmart announced a patent for its own stablecoin. This shows that stablecoins will be used for payments for real services and products in the coming years. In fact, some businesses have already started accepting stablecoins as a means of payment. So what advantage does this provide to businesses? Stablecoins are decentralized cryptocurrencies. Stablecoin transactions take place on the blockchain. This eliminates third parties and consequently intermediary fees. Therefore, accepting payments with stablecoins can create a price advantage for businesses.

Lending

Stablecoin loans are currently one of the highest-yielding opportunities for debt investors and offer double-digit interest rates. Stablecoin yields on decentralized crypto lending platforms can be as high as 15 percent.