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Stablecoins: Why Have They Become Popular And How Do They Work?

Stablecoins: Why Have They Become Popular And How Do They Work?
The emergence of stablecoins has been one of the most significant events in the digital asset industry in recent years. In this guide, you will learn why they have become popular and how the different types of stablecoins work. 
Stablecoins Are Here
In the past, stablecoins raised eyebrows and the crux of the issue was based on whether they are really supported by the number of dollars that they have claimed b ut the narrative has changed. The maturation of the market has brought about diverse companies finding institutional support that has aided them in gaining trust. For example, USDC is certified by Goldman Sachs and Circle.
The emergence of stablecoins is attributed to one of the biggest problems facing cryptocurrencies: volatility. Through different mechanisms, stablecoins aim to reduce volatility to keep their prices stable. 
Types of Stablecoins and Their Significance
Currently, there are four types of stablecoins in the market.
Fiat-Backed Stablecoins
Fiat-backed stablecoins are cryptocurrencies that endeavor to retain a stable token value that is attached to the value of a specific fiat currency. These coins largely work by controlling the token supply—either by creating or destroying tokens—in order to maintain a 1:1 ratio between the number of tokens in movement and the quantity of collateralised fiat they have in their reserves.
In this form of stablecoin , a company or central body will manage the receiving of new fiat and in return, issue a corresponding sum of fiat-backed tokens. The company is the guardian of the fiat reserves that backs up all the tokens. It is important to note that this central arrangement necessitates a certain level of trust, mostly through third-party audits, in order to ascertain or verify and validate that the fiat reserves are fully in tandem with the token supply. In essence, whenever a holder chooses to redeem cash with his tokens, the company will transfer the fiat money to the bank account of said holder and then the equivalent coins will be destroyed.
This stablecoin is considered very simple as it is easy to understand. Also, fiat currencies are deemed stable as it is backed and ensures little or no fluctuation in the underlying prices. On the other side, due to its centralised nature, it is exposed to diverse risks and liabilities such as the bankruptcy of the central body. Also, it requires a third-party (external auditors) in order to verify the credibility of the accounts and this isn’t in tandem with the code of conducts of cryptocurrency.
Examples of Fiat-backed Stablecoins are tether (USDT) and True USD (TUSD).
Asset-backed Stablecoin
As the name implies, the stablecoins are backed by assets. The most common and popular asset used as collateral is gold which is a popular precious metal. The reason for many investors’ choice of precious metals is not far-fetched. Its ability to retain its value pretty well as compared to other assets. It is most valued when the investors are able to fall back on it during a market recession while every other asset depreciates.
For gold-backed stablecoin, one coin characterises a specific value of gold, for example, one token is equal to one gram of gold. The physical gold itself is most times, kept with a trusted third party. Even though commodity-backed stablecoins are not as popular as fiat-backed coins, they still offer a credible substitute for those who prefer to transact in tokens backed by genuine, concrete value by way of precious metals.
A good example of a commodity-backed stablecoin is Digix’s Gold token (DGX). 
Cryptocurrency-Backed Stablecoin
These are coins backed by other digital currencies such as bitcoin or ether. Crypto-backed coins are not at the mercy of a single currency but rather backed up by a mix of cryptocurrencies. This ensures a reduction in volatility risk and eliminates one point of failure. Due to this, many crypto-backed stablecoins are over-collateralised in order to survive the extreme price fluctuations of the underlying cryptocurrencies. The most common form of crypto-backed stablecoins entails users staking (and locking-up) a certain amount of cryptocurrencies into a smart contract, which will then result in the creation of a fixed ratio of stablecoins.
A well-known example of crypto-backed Stablecoin is the MakerDAO’s Dai token (DAI). It is a decentralised, crypto-backed coin with a value that is fixed on U.S. Dollars, it doesn’t rely on any third-party since it operates on a Blockchain, rather, it accomplishes price stability through an independent system of smart contracts, called Collateralised Debt Position (CDP), which respond to diverse market undercurrents.
Seignorage-Style Stablecoin
This is the only category of stablecoins that is not backed by anything. These coins make use of an algorithmically governed method to contract and develop a stablecoin’s money supply. Therefore, as the demand for the coins increases, the supply of stablecoins are created to minimise price, returning it to stable levels. The foremost purpose here is to get the coin’s price as close as possible to $1.00. 
This guest contribution was provided by Precious Onyejegbu, founder of NGExchanger , a cryptocurrency exchange platform in Nigeria.
The post Stablecoins: Why Have They Become Popular And How Do They Work? appeared first on BitcoinAfrica.io .

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