Stablecoins are digital currencies that are pegged to an external asset such as fiat currency or another cryptocurrency to maintain price stability and protect users from the volatility of ‘normal’ cryptocurrencies such as the likes of Bitcoin or Ethereum. As such, they play a crucial role in the machinery of digital finance, smoothing exchanges, and increasing the efficiency and security of digital exchanges. The most commonly used peg is the US dollar, meaning that the value of each token will remain static like regular real-world currencies. To see how central they are to the structure of DeFi, Jerusha Koya, an expert in the research, asserts that ‘stablecoins play an integral role in bringing fiat [ie, non-crypto] currencies into the volatile cryptocurrency market which, subsequently enhances the underlying infrastructure of DeFi by enabling stable transactions for lending and borrowing, and earning interest.
Now, there are different types of stablecoins, including fiat-collateralised, crypto-backed and algorithmic stablecoins, with each enjoying some level of value stability through a different mechanism. For instance, fiat-collateralised stablecoins are essentially backed by real-world currencies in the form of a 1:1 reserve that can be directly redeemed. Crypto-backed stablecoins, on the other hand, use other cryptos such as Bitcoin to hold reserves, but due to the volatility of prices in the crypto markets often hold a little more in reserve. Meanwhile, algorithmic stablecoins owe their value to software algorithms written in code that regulates the supply of the stablecoins in response to the forces of supply and demand. Beyond price stability, stablecoins are beneficial to the crypto space because they provide increased liquidity in the crypto markets, make it easier to transition between fiat and digital currencies, ensure regulatory conformity, and open up more access to DeFi platforms.
There are several leading examples, such as Tether (USDT), the first and most popular stablecoin, USD Coin (USDC), famed for transparency and full collateralisation, DAI, created by DAO (decentralised autonomous organisation) operating on Ethereum network, and more recently the PayPal USD (PYUSD) that leverages the power of PayPal payment infrastructure and features. Stablecoins are fundamental to cryptocurrency scalability, making transactions easier and more friendly.
Source: Economic Times
