If you are not familiar with stable coins, this is an opportunity for you to understand them.
The currency was used as a medium of exchange, it was widely accepted by the mob as it promises a monetary value. It literally stores a monetary value. If you keep saying 100 dollars in the currency it will be having the same value the next day and the day after that, but things are different in cryptocurrency.
A cryptocurrency is a place where the market is highly volatile. Imagine bitcoin which was once at a few dollars reached somewhere around 20000 dollars and now stays at nearly half of its all-time high. Cryptocurrency usually experiences price changes every day. A factor that conventional currencies are not subjected to.
Will you be ready to take a 100$ currency note or cryptocurrency valued at 100$ if someone asked you to choose? Consider the fact that the value of your cryptocurrency might be 150$ tomorrow or 50$.
Stable coins are another type of cryptocurrency. As the name indicates the are more stable against the market volatility. They offer price stability and are backed by a reserve asset.
The ideal behavior that should be coupled with a cryptocurrency is that they should have the lowest possible chances of inflation. People should be ready to spend them instead of saving them to make profits. Stable coins are a step towards merging this ideal behavior with crypto coins.
why are cryptocurrencies unstable?
To answer this quest we should first find the reason for the stability of conventional currencies.
1.conventional currency is backed with an asset such as gold or forex, these assets literally act as collateral and are not subject to the wild swings in markets.
2. Presence of a regulatory authority like the central bank in most cases adds to the stability m even if the market fluctuations affect the currency, the supply and demand are usually controlled by the authorities to cope up with the situation.
There are mainly three types of stable coins which are made stable in different ways.
Non- Collaterized
Unlike the other stable coins these do not have a reserve asset, but it comes with something similar to the central bank system in conventional currency. The central bank usually changes the supply and demand of the notes to overcome market swings. Here the function of the central bank is achieved by a smart contract in a decentralized system that autonomously works to regulate the supply according to demand.
Fiat- Collaterized stable coins
They are usually backed by a dollar or other precious metals and commodities such as gold, silver, oil, etc. The reserves that back these Collaterized stable coins are kept with independent custodians. They are properly audited in intervals for compliance.
crypto Collaterized stable Coins
The idea refers to cryptocurrency that is backed by another cryptocurrency. You may already have doubts about this since the very on the idea of a stable coin is to stabilize the value, and here the backup reserve is another cryptocurrency which can have huge fluctuations in price.
These price fluctuations of the reserve cryptocurrency are avoided by something called the "over Collaterized" method.
Simply imagine you are about to create 1000 stable coins that are worth 1000 dollars. If these coins are backed up with bitcoin, the reserve will be usually worth twice the amount. That is, bitcoin worth $2000 is pledged to create new coins.
If this method is followed even if the reserve currency faced a 50% decrease in price, the value of the stable coin can remain unaffected.
Stable coins are of course the first step to increase the people's trust in cryptocurrency. As I have mentioned, what good is a hundred dollars if it cannot be used to pay the sum of 100 dollars because of a price drop?
