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Concept
A stablecoin is a cryptocurrency (or a digital token) that derives its value from real-world assets (RWAs), such as commodities, precious metals, real estate, or other tangible assets, intangible assets or financial assets. It is a digital asset whose value is pegged to a reference asset, which is either fiat currency, exchange-traded commodities (such as precious metals or industrial metals), or another cryptocurrency. Stablecoins (also, asset-backed cryptocurrencies) are created by establishing a sort of link between the value of the digital token to the underlying asset using blockchain technology. The value of this asset-backed token (ABT) or backed crypto asset is referenced to the performance and market value of the asset it represents.
Linkage to an underlying asset provides stability mechanism to the performance of a cryptocurrency and reduces the volatility that most cryptocurrencies are characterized with. Using real-world assets as underlying makes such coins a more secure and less volatile investment vehicle. The referenced physical assets or other digital assets have a sort of stable value, whereby supporting such the stability of such a token. The underlying assets may widely vary depending on the scope of tokenization, including real estate properties, precious metals like gold or silver, commodities, or artworks, and collective interests (fanship).
A stablecoin is created and issued converting ownership of real-world assets (RWAs) into digital tokens. The linkage helps reduces the volatility of a token thanks to the direct relation between the value of the cryptocurrency and tangible assets. This instills the aspects of confidence and stability in the tokens as investment compared to highly speculative cryptocurrencies. Furthermore, the currency allows investors to have fractional ownership of valuable assets- that is, a portion of the asset without having to purchase the whole of it.
Main types of stablecoins
- Crypto-backed stablecoin: a stablecoin that is backed (collateralized) by reserves of other cryptocurrencies (or cryptoassets). In essence, a stablecoin is a cryptocurrency (or a digital token) that derives its value from real-world assets (RWAs), such as commodities, precious metals, real estate, or other tangible assets, intangible assets or financial assets. It is a digital asset whose value is pegged to a reference asset, which is either fiat currency, exchange-traded commodities (such as precious metals or industrial metals), or another cryptocurrency. Crypto-backed stablecoins operate on the principle of overcollateralization — meaning that the value of assets held in reserves (that of the cryptoassets) exceeds the value of the pegged stablecoin. In this context, overcollateralization aims to mitigate the inherent volatility of the reserve assets (underlying assets). Users lock up their cryptoassets, on the blockchain, via a smart contract and receive an equivalent value in stablecoins that is usually lower than the value of backing cryptoassets. This means that if cryptoassets go down in value, the value of the collateral will be less, and drives certain positions to default on payment. The additional amount of collateral can account for this adverse scenario, and if the value of the collateral drops even further, the protocol automatically liquidates a portion of the collateral to cover the stablecoin issued.The prices of crypto-backed stablecoins are pegged to a broad set of assets, not necessarily fiat currencies, and hence users can reasonably mitigate the effect of inflation or regulatory measures on performance of such coins. For example, since Bitcoin is a decentralized currency, its value does not correlate to that of fiat currencies like the dollar or euro. In times of high uncertainty, crypto-backed stablecoins may provide a better venue for market participants.
- Fiat-backed stablecoins (fiat crypto tokens): tokens (and a type of stablecoin) that are created and issued on a fiat currency. The token represents the currency of a country (the US dollar, Euro, Pound sterling or Russian ruble) and by means of purchase and sale of which a holder / user can deposit and withdraw money and electronic money, since the token represent the currency it is pegged to). A fiat currency is a currency that has no intrinsic value but is issued on the creditworthiness of a government, but without direct connection with (i.e., convertibility to) a precious metal commodity (like gold or silver). However, it may be supported by reserves of such metals held by the issuing central bank. Fiat currency is established as a legal tender by government regulations. Legal tender is a form of money that courts of law and the broader legal system in a country legally recognize as satisfactory means of payment for any monetary debt within its jurisdiction. In other words, it is a form of money legally valid for the payment/ settlement of debts (and coutervalues) and that must be accepted for that purpose when presented by a legal or corporate person.
- Algorithmic stablecoins: a type of mirrored assets– a digital asset that mirrors the price of a fiat currency (usually, the U.S. dollar). The coin is programmed to adjust the circulating token supply so as to maintain its peg with the underlying currency. To that end, these coins rely on programmed algorithms to dynamically adjust their supply in response to changes in demand.
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