What Are Stablecoins in Cryptocurrency?

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By Connor
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A Stablecoin is a cryptocurrency whose value is tied to a reserve asset, such as the US dollar, gold, various commodities, or even other cryptocurrencies. Stablecoins add price stability to an often volatile and fluctuating Decentralized Finance (DeFi) ecosystem.

Cryptocurrency is famously volatile. Take Bitcoin, for example. In its mind-blowing journey to 6,000,000% gains – yes, you read that right, 6 million per cent – in just 12 years, it’s had some mammoth dips along the way. For instance, in 2011 when it crashed 99% in a single day. A financial rollercoaster crossed with a wild bucking bronco, but those who were able to HODL on to their Bitcoin have now made a fortune.

In contrast, stablecoins are the opposite of a bucking bronco – they’re a wooden horse. They barely move because they’re pegged to underlying assets in order to limit price fluctuations. But there can be differences in how they’re pegged, which gives rise to the four main types of stablecoins:

What are the Different Types of Stablecoins?

 Traditional Collateral (Off-Chain)

These are intended to be backed 1:1 by fiat currency, which means that fiat collateral should be held in reserve with a central issuer or financial institution, and its value should remain proportionate to the number of stablecoins in circulation. For example, if an issuer has $1 million of fiat currency, then they should only distribute 1 million stablecoins, each worth one dollar.

Some of the best-known stablecoins in this category are Tether (USDT), USD Coin (USDC), and Paxos Standard (PAX).

Crypto Collateral (On-Chain)

As the name suggests, this type of stablecoin is backed by another cryptocurrency, and the collateralization process happens on-chain using smart contracts.

When you purchase this kind of stablecoin, your crypto is locked into a smart contract and you receive tokens of equal value. You can then put your stablecoin back into the same smart contract to withdraw your original crypto that you put up as collateral amount.

Algorithmic Stablecoins (On-Chain)

Instead of using fiat or cryptocurrency as collateral, algorithmic stablecoins use algorithms and smart contracts to manage the supply of tokens in circulation. The way this works is that when the market price falls below the price of the fiat currency it tracks, the algorithm reduces the number of tokens in circulation. Alternatively, if the price of the token goes above the price of the fiat currency it tracks, the algorithm mints new tokens which enter circulation to adjust the stablecoin’s value downward.

USDL – the stablecoin native to Liquid Loans – falls into this category.

Commodity-Backed Stablecoins (Off-Chain)

Commodity-backed stablecoins are collateralized by physical assets like precious metals, oil, and real estate. The most popular commodity to be collateralized is gold, and Tether Gold (XAUT) Digix (DGX) and Paxos Gold (PAXG) are three of best known gold-backed stablecoins.

Since commodities tend to fluctuate in price more than fiat, commodity-backed stablecoins have a greater potential to fluctuate too.

The Risks of Stablecoins

Stablecoins in cryptocurrency are risky for three main reasons – security risk, counter-party risk, and reserve-backing risk.

  • Security risk: Stablecoins must be held on a platform, whether in a crypto wallet or on an exchange, which presents the risk of software vulnerabilities.
  • Counter-party risk: Stablecoins depend on both the party holding the reserve-asset and the party issuing the coins. A breakdown in trust at any level can put your coins at risk.
  • Reserve-backing risk: Stablecoins depend on the value of the asset backing them. Without the reserve asset, the value of your coins cannot be guaranteed.

Stablecoins are really only as stable as their underlying asset, and those pegged to commodities tend to be the least stable. In 2018, the research firm Santiment examined various stablecoins and noted that 16 out of the 24 failed stablecoins in its study were pegged to gold.

Conversely, USDL is pegged to the US dollar, so it’s much more stable than many other stablecoins.

What can you do with the Liquid Loans stablecoin, USDL? The short answer is, whatever you’d like!

But first, let’s look at the different ways you can acquire USDL:

–– Borrow it against your PLS

In this scenario, you create a Vault, decide your collateralization level (minimum 110%), and voila, you’ve got yourself some shiny USDL.

–– Buy it with fiat (Coming soon!)

At Liquid Loans, we’re working on exchange listings as well as on/off ramps to make it super easy for everyone to buy and sell USDL and our native token LOAN.

–– Receive it as a reward for staking LOAN

When you stake your LOAN tokens, you earn USDL and PLS as revenue from borrowing and redemption fees. Watch the video below to learn how it works.

–– Receive it as payment or as a gift

Sending and receiving USDL peer-to-peer is just as easy with any other crypto. And since it’s on Pulsechain it’s super cheap and fast to send.

Once you’ve got some USDL in your wallet, you can:

–– Transfer it to your exchange

From there you can cash it out into fiat and send it to your bank account to go and spend on anything your little heart desires.

–– Buy more crypto

If you want to, you can use your USDL to buy more PLS, HEX, LOAN, or any other cryptocurrency for which there is an available pair. The blockchain is your oyster.

–– Provide stability

Deposit USDL to the Liquid Loans Stability Pool right inside the Liquid Loans protocol.

–– Provide liquidity

Head to PulseSwap and use it as half of the USDL:PLS pair.

Now that you know a little more about stablecoins, especially USDL (the best stablecoin ever, although we admit we may be biased), why not open up the Liquid Loans dApp and take a look around?

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Disclaimer:Please note that nothing on this website constitutes financial advice. Whilst every effort has been made to ensure that the information provided on this website is accurate, individuals must not rely on this information to make a financial or investment decision. Before making any decision, we strongly recommend you consult a qualified professional who should take into account your specific investment objectives, financial situation and individual needs.

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Connor

Connor is a US-based digital marketer and writer. He has a diverse military and academic background, but developed a passion over the years for blockchain and DeFi because of their potential to provide censorship resistance and financial freedom. Connor is dedicated to educating and inspiring others in the space, and is an active member and investor in the Ethereum, Hex, and PulseChain communities.

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