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What are stablecoins and how do they work?

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As cryptocurrencies have grown in popularity throughout 2021, there is one area that has seen particularly noticeable gains: stablecoins. With over 200 different global stablecoins in circulation, currently valued at $160 billion — six times what it was a year ago — stablecoins have become increasingly attractive to those looking for a less volatile way to interact with crypto markets. 

In this article, Checkout.com explains:

  • What is a stablecoin
  • What global stablecoins exist
  • How does a stablecoin work
  • Why stablecoins are growing in popularity
  • The different use cases for stablecoins

What is a stablecoin?

Stablecoins are crypto tokens typically pegged to a fiat currency, like USD or EUR, so they can usually be exchanged one-to-one for the non-cryptocurrency in question. As swings in crypto prices occur, this feature allows businesses and consumers to use crypto for regular payments, allowing the value of goods exchanged to remain stable even as crypto prices fluctuate. At the same time, payments using stablecoins are still fast, transparent, and secured on the blockchain.

Simply put: stablecoins allow people to use crypto, without worrying about the extreme price volatility many cryptocurrencies incur. 

What global stablecoins exist?

USD coin (USDC) is an example of a stablecoin, with over 40.8 billion coins in circulation. Given that stablecoins can be pegged to any fiat currency, some crypto companies offer more than one, such as the largest, Tether, whose currencies are pegged to the Euro (EURT) and the US Dollar (USDT), respectively. 

List of top stablecoins by market capitalization:

  • Tether (USDT)
  • USD Coin (USDC)
  • Binance USD (BUSD)
  • Dai (DAI)
  • TerraUSD (UST)

How do stablecoins work? 

At the most basic level, an exchange offering a fiat-backed stablecoin will deposit a dollar — or whichever currency its coin is pegged to — for every stablecoin it places in circulation. This is what pegs the stablecoin to that currency and theoretically enables holders of stablecoins to exchange their stablecoins for fiat currency at a one-to-one ratio. 

While fiat-backed stablecoins make up most of the market capitalization, there are stablecoins in circulation that are pegged to other assets. These include:

  • Stablecoins pegged to gold and other precious metals, such as Digix Gold
  • Stablecoins pegged to other crypto assets. Dai is the best example
  • Algorithmic Stablecoins, also known as Non-Collateralized Stablecoins, such as the Ampleforth or AMPL token

Although there are differences in the mechanics that power different types of stablecoins, the result is the same: offering the stablecoin holder a high degree of certainty in the asset's value.

Why are stablecoins growing in popularity?

Even before the pandemic, paying with digital cash was becoming more and more attractive. Now, after almost two years of living with the shifting regulations in the physical world, buying online using digital money is more popular than ever. But these trends have resulted in many different stores of digital money, which don't synchronize easily. 

Take a Venmo balance, for example — what good is holding USD in a Venmo account if no one else is using Venmo? Stablecoins offer an alternative: a single form of digital currency that, since it's managed on the blockchain, will translate across payment systems, no matter which platform you want to pay on. 

There's also the fact that: 

Stablecoins are low volatility assets: Because they're usually pegged to fiat currencies, their value doesn't fluctuate in the same way as other crypto assets. As a result, consumers and businesses can treat stablecoins much like traditional currencies. 

Stablecoins enable fast and low-cost payments: With stablecoins, payments can easily be made cross-border, making it easier for vendors to sell to international clients in a globalized marketplace. These payments are also fast and lower-cost, making them much more attractive as a way for small businesses to accept payment.

Stablecoins can enable micropayments: Micropayments — where consumers pay incrementally for their use of content online — is a practice that is currently prohibitively expensive in traditional banking. As Circle’s CSO Dante Disparte told Associated Press, "If you could receive a streaming payment or an accrued payment, or a payment that is contractually obligated to you in software, and it costs no more to send $1, or a billion dollars, all of a sudden you’re unlocking quite a lot of economic activity."

For crypto investors, stablecoins are particularly attractive right now because the prices of all cryptocurrencies tend to be volatile. In this sense, stablecoins offer a 'safe haven' for those looking to avoid market volatility. Stablecoins can also be 'staked', allowing owners to earn yields on holdings while avoiding the ups and downs of crypto prices.

But in the future, stablecoins could also offer a way into digital payments for unbanked segments of the population, which are not served by traditional banking, according to economist Eswar Prasad. This could be particularly helpful, for example, for governments issuing stimulus payments and bringing new consumers into the world of digital payments.

Stablecoins and the future

It’s currently not clear how governments will decide to regulate stablecoins, although there are signs that, in the U.S. at least, they might be subject to the same scrutiny as banks.

The main question is whether stablecoin operators hold sufficient cash reserves to meet their promise of a one-to-one exchange of value with the dollar. For example, if everyone started taking their coins out at once, it could have devastating effects.

The benefits of stablecoins, however, are clear to governments too. Indeed, the Biden administration recently said that stablecoins could change how we pay for everything. As buying digitally becomes ever more embedded in our lives, stablecoins offer an affordable, stable, and easily accessible way for consumers and businesses to move value globally, today and in the future.

About the Author

James is Checkout.com's Senior Content Marketing Manager, writing about all things to do with digital payments and the digital economy. James was previously the Senior Content Manager at Tradeshift and also headed up the Global Editorial Team at Treasury Today and Treasury Today Asia.

Profile Photo of James Hayward