Introduction
Stablecoins are digital assets that aim to keep their value constant relative to a reference asset, most commonly fiat currencies like the U.S. dollar, euro, or yen. Unlike Bitcoin or Ethereum, whose values can fluctuate significantly, stablecoins are designed to be predictable and stable, making them useful for everyday transactions, remittances, and as a safe haven during market turbulence.
Stablecoins bridge the gap between traditional finance and the crypto world. They allow users to transfer value globally without the fear of price fluctuations. Here are a few key uses:
- Remittances: Sending money across borders can be costly and slow. Stablecoins enable faster and cheaper transactions.
- DeFi (Decentralised Finance): Stablecoins are crucial in the DeFi ecosystem, where they are used for supplying, borrowing, and earning interest.
- Hedging: Traders and investors use stablecoins to move out of volatile assets without converting back to fiat.
- Payments: Merchants can accept stablecoins for goods and services without worrying about price volatility.
How Do Stablecoins Work?
Stablecoins achieve stability through various mechanisms:
- Fiat-collateralised Stablecoins: These are backed by reserves of fiat currency held in a bank account. For every stablecoin issued, an equivalent amount of fiat currency is held in reserve. Examples include Tether (USDT) and USD Coin (USDC).
- Decentralised Stablecoins: These operate without a central authority and are typically issued, redeemed, and governed by smart contracts on a blockchain. Smart contracts can manage the collateral requirements and issuance based on predefined rules in a trustless and transparent process. Aave’s GHO is one example of this kind of stablecoin.
- Algorithmic Stablecoins: These rely on smart contracts and algorithms to maintain their peg. Instead of being backed by reserves, these stablecoins use mechanisms like minting and burning to control the supply and stabilize the price.