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Unlike other cryptocurrencies like Bitcoin and Ethereum, stablecoins are cryptocurrencies that have been designed to keep a stable value.
Placing a greater emphasis on stability over volatility can be a huge draw for some investors.
Many individuals can be turned off from large swings and uncertainty presented by cryptos relative to other traditional assets.
Stablecoins control for this volatility by being pegged to another cryptocurrency, fiat money, or to exchange-traded commodities, including gold, silver, or others.
Advantages of Stablecoins
Of note, stablecoins redeemable in currency, commodities, or fiat money are also said to be backed, whereas those tied to an algorithm are not considered to be so.
There are several advantages of asset backed crypto. First, these coins are stabilized by assets that fluctuate outside of the crypto space, that is.
This can help mitigate the financial risk associated with these assets.
For example, Bitcoin and altcoins are highly correlated, so that cryptocurrency holders cannot escape periodic price falls.
Stablecoins control for this vulnerability, allowing for the diversification of risk in a portfolio.
Stablecoins also possess a mechanism for redeeming the asset backing them.
This grants an additional level of confidence associated with the coin and are unlikely to drop below the value of the underlying physical asset, due to the effects such as arbitrage.
For example, fiat-pegged coins are coins that are tied to a specified amount of fiat currency, usually on a one-to-one ratio (i.e.1 StablecoinX = $1).
The companies that issue these currencies must have fiat reserves in the equivalent amount of the stablecoins they have issued.
Crypto-pegged stablecoins constitute coins that are tied to a specified amount of another cryptocurrency, such as Bitcoin or Ethereum.
Algorithmic stablecoins use supply-and-demand to automatically maintain a stable value.