Cryptocurrencies are highly volatile; they can go up and down by a huge margin, mostly without any warning. This could be a reasonable stablecoin that was created, as they do not change their value concerning the market and are kept pegged to their corresponding asset or algorithm. We can consider Stablecoins as a safety net in the highly unstable market.
Based on the asset with which they are pegged, stablecoins are categorized into Fiat-backed, a coin backed by a currency such as USD or EUR. Crypto-backed, backed by a cryptocurrency like BTC, ADA, etc., and algorithmic, they employ computer algorithmic codes to peg its value.
The practicality of stablecoins essentially provides market capitalization and ease of movement of funds, inviting regulators as they are now keeping a close eye on stablecoins. Many countries are in the process of launching their Central Bank Digital Currencies (CBDC).
Use Cases
Stablecoins provide a very interesting use case compared to cryptocurrencies or tokens. Let us consider that person X purchases a collectible from person Y and pays the amount in Bitcoin; at the time of dealing, the BTC was at $18,500, and by the time it was delivered, the price dropped to $18,250. It could be considered if the price was just 1 BTC, but what about 100s of BTC worth? Then this volatility could be harmful.
Hence stablecoins provide a great alternative, USDT is pegged with USD, and its price fluctuates between 0.99 and $1.1; this gives stable coins a great reach above all other coins and tokens.
Creating a coin that could track the price and value of another commodity requires a pegging mechanism. And there are many ways to do that; some use collateral, some use algorithms, and some use burning and minting to peg its value.
Fiat-backed stablecoins
A fiat-backed stable coin keeps fiat currency such as USD, GBP, and Euro in reserves. Users can exchange these types of stablecoins as per the pegged value. And if the fiat value is based on dwindling, they manage it by getting more and removing some.
Crypto-backed stablecoins
They work the same way as the fiat-backed stable coins, with the primary difference being that they are backed by cryptocurrency, and the same is kept as collateral. Due to high volatility, crypto-backed stablecoins generally over-collateralize, and the reserves are measured against the price swings.
Algorithmic Stablecoin
They take a different approach by removing fiat and cryptocurrency from the mix. Instead, they employ algorithms and smart contracts to manage the supply. In this case, the algorithm will burn old or mint new coins per the requirement.
Nancy J. Allen is a crypto enthusiast and believes that cryptocurrencies inspire people to be their own banks and step aside from traditional monetary exchange systems. She is also intrigued by blockchain technology and its functioning.
Source: https://www.thecoinrepublic.com/2022/12/31/a-guide-to-stablecoins/