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What are Stablecoins, how they work, how to buy them, and other questions answered

What are Stablecoins, how they work, how to buy them, and other questions answered

What are Stablecoins, how they work, how to buy them, and other questions answered
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By CNBCTV18.com Dec 30, 2021 4:07:17 PM IST (Published)

While Bitcoin and other cryptocurrencies have generated massive returns this year, they have their own set of issues, like high volatility. However, investors can safeguard themselves against this volatility by investing in stablecoins. Stablecoins are cryptocurrencies backed by real-world assets such as commodities, fiat currency (issued by the government), gold, or other cryptocurrencies. Here's all you need to know about them

The massive returns generated by Bitcoin and other cryptocurrencies over the past few years have compelled a lot of investors to put their money in the digital currency markets. However, cryptos are volatile and risky as they are not regulated by any central authority. Plus, their price is entirely dependent on the demand and supply of the coins. So, what can investors do to safeguard their digital currency portfolio against such volatility? The alternative is to invest in stablecoins.

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But what are stablecoins and how can you invest in them? To give you a better idea, here is everything you need to know about stablecoins.

What are Stablecoins?
Stablecoins are cryptocurrencies backed by real-world assets such as commodities, fiat currency (issued by the government), gold, or other cryptocurrencies. They are a result of the need of early crypto investors, who experienced extreme volatility, for digital alternatives of fiat currency; something that could hold value over time. The value of stablecoins does not fluctuate as much as the other cryptos such as bitcoin or ether and they can also be made stable using computer algorithms.
Stablecoins are digital assets that have a stable valuation like a fiat currency but also provide utility and mobility of a cryptocurrency. Put simply, they can be seen as the bridge between a volatile cryptocurrency and a stable fiat currency.

What are different types of stablecoins?
There are essentially four types of stablecoins differentiated based on three criteria:
  • is there an issuer/custodian responsible for satisfying any attached claim;
  • how decentralised is decision-making over the stablecoin;
  • the underlying value of the stablecoin and its stability in the currency of reference.
  • Fiat-backed or tokenised funds: The value of these stablecoins is pegged to the collateral that backs them. For example, if a stablecoin is backed by a fiat currency, say the US dollar, it means every stablecoin is equal to $1. Hence, if the issuer of the stablecoin has $3 million in reserve, they can only issue three million stablecoins in exchange for it.
    Tether is an example of a fiat-backed stablecoin.
    Crypto-backed or on-chain stablecoins: These coins are backed by another asset, typically other cryptocurrencies, such as ether or bitcoin. The value of the stablecoin is always proportionate to the value of the underlying cryptocurrency. These crypto-backed stablecoins use smart contracts and do not need an issuer or central custodian.
    Dai is an example of an on-chain stablecoin backed by the units of ether.

    Securities/commodity-backed or off-chain stablecoins: These stablecoins are backed by other traditional assets such as securities or commodities. They can be collateralised against precious metals like gold, oils, or real estate.
    Investors can also redeem their investment in stablecoin and get physical delivery of the collateral. Therefore, there is a need for a custodian. However, token redemption is only possible for set measurements of the collateral.
    For example, many issuers only deliver gold bars when you redeem a stablecoin backed by gold. Hence, if one token of the stablecoin is equal to one gram of gold, the number of stablecoins units required would be in proportion to the weight of the gold bar.
    Gold is more popular as a commodity to be collateralised. Tether Gold (XAUT) and Paxos Gold (PAXG) are among the most liquid gold-backed stablecoins.
    Algorithmic stablecoin: An algorithmic stablecoin is not backed by any collateral. But, it uses a special algorithm to maintain the prices of the coin. If the price of the stablecoins falls below the price of the fiat currency it tracks, the algorithm reduces the number of tokens in circulation.
    While, if the prices of the stablecoin rise above the fiat currency it tracks, the algorithm increases the number of tokens in circulation to accordingly adjust the value of the stablecoin. It does not need any custodian for the underlying asset and operations are totally decentralised.
    NuBits is one such algorithmic stablecoin that has been around since 2014.

    Also Watch // A round up of crypto strategies of 2021

    How can you buy stablecoins?
    You can buy stablecoins the same way you buy other cryptocurrencies from the various crypto exchanges. You can buy these coins from exchanges such as WazirX through a simple process:
    • Visit their website
    • Create an account by providing the required details.
    • Fund your digital wallet, and,
    • Start trading or investing in Stablecoins
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