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What are stablecoins?

What are stablecoins?

May 5, 2022
3
 min read

Stablecoins are tokens designed to have stable prices by being pegged to a “stable” asset like the US dollar.

By Alan, Peter

Stablecoins are tokens designed to have stable prices by being pegged to a “stable” asset like the US dollar.

Globally, stablecoins have a $150B+ market cap (~5% of the $2.7T cryptocurrency market). As of December 2021, the top 5 stablecoins are tether, USDC, Binance USD, Dai, and Terra:

Source: CoinGecko

How do stablecoins stay stable?

Stablecoins keep prices stable in different ways:

  1. Fiat-backed stablecoins are backed by fiat currency (e.g., US dollar) held in a regulated financial entity. Examples include Tether and USDC
  2. Crypto-backed stablecoins are backed by cryptocurrencies and work like a collateralized loan. For example, to get a loan for $50 in DAI (a crypto-backed coin pegged to the US dollar), you might have to park $100 ETH. If ETH goes up in value, then your borrowing power will increase. If it goes down in value, then you might have to park more. You get your ETH back when you return the DAI.
  3. Algorithmic stablecoins rely on algorithms to control the money supply, similar to how a central bank prints and destroys fiat currency based on market demand. Examples include Terra USD.

Inflation is still a problem for stablecoins that are pegged to the US dollar or another fiat currency. As a result, DeFi protocols like Olympus DAO have started exploring other ways to build a global reserve currency. We’ll cover Olympus in a future post.

Why hold stablecoins?

People hold stablecoins to:

  1. Earn yield while minimizing volatility. Stablecoins offer high yields (e.g., 10%+) without massive price swings. Without stablecoins, you’ll have to swap back to fiat currency to hold a stable asset.
  2. Transfer money. It’s often cheaper and faster to pay someone in stablecoin than fiat currency, especially if you’re sending money internationally.

Before we discuss DeFi further, let’s take a detour and cover how you can earn passive interest on stablecoins and other assets through CeFi (centralized finance) platforms.

Up next: How to earn CeFi yield?

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