How do stablecoin works is a question that was triggered by bringing stability to an otherwise highly volatile market.
Stablecoins have completely transformed the cryptocurrency industry.
Investors and users must comprehend how various stablecoin keep their stable value which is the reason for this blog post on how do stablecoin works?
In this blog post, we will examine how various stablecoin types operate and offer examples to show how each preserves its stability.
Types of stablecoin and how do they preserve their stability
Fiat-collateralized stablecoin
Stablecoins that are backed by fiat money are pegged to established currencies and keep their value consistent by keeping a reserve of the underlying fiat currency.
This type of stablecoin can be pegged to a fiat currency of any country such as the United States Dollar, Nigerian Naira, Great Britain Pounds, Euro among others.
One of the most well-known fiat-backed stablecoins is Tether (USDT), where each USDT token is fixed to the US dollar.
By keeping USD reserves equal to the quantity of USDT tokens in circulation, Tether keeps its stability.
For users to have faith in these reserves, they must be transparent.
Crypto-collateralized stablecoin
Stablecoins that have been crypto-collateralized are backed by other cryptocurrencies, and smart contracts make sure that the value of the collateral is greater than the supply of the stablecoins.
This type of stablecoin is backed by other volatile crypto assets but due to possible volatility in the collateral assets, they are often over-collateralized.
An illustration of a stablecoin with crypto-collateral is MakerDAO.
The MakerDAO stablecoin, DAI, is supported by a number of cryptocurrencies, primarily Ethereum (ETH).
Users receive DAI tokens in exchange for locking their ETH as collateral. Stability is maintained by smart contracts that keep track of the collateral’s value and make sure it is higher than the market value of the DAI tokens.
Algorithmic Stablecoins
Algorithmic stablecoins rely on intricate systems and algorithms to keep their stability without the use of direct collateral or pegs to outside assets.
Ampleforth (AMPL) and TerraUSD (UST) are examples of Algorithmic stablecoin.
The algorithmic stablecoin, Ampleforth, dynamically modifies its supply to maintain price stability.
The protocol changes the number of tokens in each user’s wallet when the price of AMPL varies from the intended price.
By adjusting the supply, the price is able to return to its target level and remain stable.
In the case of UST, the protocol was linked to LUNA.
Hybrid Stablecoins
Hybrid stablecoins combine several ways to ensure stability, frequently including components of collateralization, algorithmic adjustments, and fiat-backing.
The USDD stablecoin Tron’s decentralized autonomous organization (DAO) is an example of hybrid stablecoin.
According to Justin Sun, “USDD is a hybrid model of DAI, UST, and other stablecoins”.
In conclusion, there are various sorts of stablecoins, and each one uses a different mechanism to keep stability.
While crypto-collateralized stablecoins protect their value using smart contracts and collateral, fiat-backed stablecoins preserve stability with reserves of the underlying fiat currency.
Hybrid stablecoins integrate several techniques, whereas algorithmic stablecoins dynamically alter their supply in response to market demand.
Investors and users looking for stability in the cryptocurrency market must comprehend how each sort of stablecoin keeps its stable value.
Understanding these concepts on how do stablecoin works and looking at examples will help you on how to use stablecoins to confidently navigate the crypto world and make informed decisions.
About Kumo
Kumo, registered as Kumo Technologies Inc in Delaware, U.S. is a fiat and crypto social payment app which allows users to exchange fiat (NGN) to crypto, save and earn interest in dollar with as low as $5, utility payment such as DSTV subscription, airtime, data among others.
Kumo wallet is your all-in-one social payment app for seamless payment solutions.
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