“Cryptocurrencies are known for their volatility and it is for this reason many investors shy away from indulging into crypto markets. With time, a solution to counter the volatility of the cryptocurrencies was devised and it is now known as the Stablecoins. This article will make you understand how these Stablecoins stabilize the volatility of cryptocurrency and where they get handy”.
The Stablecoin Basics
Stablecoins are the cryptocurrency coins whose value is pegged to an underlying asset such as US Dollar, Euro, any commodity etc. These cryptocurrencies are stable which means that their price is not volatile and will reflect the price of the underlying collateral. For example a stable coin such as USDT is pegged against the value of US Dollar, its value will always be equal to 1 US Dollar.
This ensures that the volatility is stabilized and at the same time the benefits of the cryptocurrencies will be reaped.
The Stablecoin Types
There are various types of stablecoins and they are discussed below:
Fiat and Commodity Backed Stablecoin
These are the most common type of stable coins whose value are pegged against fiat currencies such as US Dollar, Euro or against commodities such as gold, silver, oil etc. To back a stablecoin or to issue a stable coin of this type a issuer must collateralize the equal amount of fiat or commodity value. Examples of these types of stable coins include USDT, BUSD etc.
Crypto Backed Stablecoins
These Stablecoins are backed by collateralizing the crypto assets. But, this type of Stablecoins has a problem of crypto volatility and thus over collateralization has to be done in order to issue the same amount of coin and thus are not that viable.
Algorithm Based Stablecoins
This is the latest form of Stablecoins in which no collateral is required but the price of the stable coin is determined by the underlying smart contract working on decentralized autonomous software. The price is controlled by reducing and increasing the coin supply during a fall and rise in the price of the coin respectively.
The Power to Stabilize
The power of stablecoins to stabilize the volatility comes from the underlying principles:
As the Stablecoins are pegged to the underlying collateral, their price moves in tandem with the price of the collateral. If a collateral has a stable price over time, it will stabilize the price of the coin and thus prevent volatility.
As, the issuer of a stablecoin can issue only that amount of coins that he has a collateral for. This puts a capping on the coin supply and thus maintains the price of the coin.
An investor keeping at least 30% of his portfolio in stablecoins will help in reducing the volatility risk in the market and will also provide a chance for Dollar Cost Averaging and Value Averaging that will also stabilize the portfolio of the investor over time.
Disclaimer: The article is meant for the educational purpose only and in no way it should be considered as financial advice. Own research on the topic is advisable.
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