Cryptocurrency is one of the hottest markets for investors to put money into right now. Since Bitcoin was launched as the first crypto coin in 2009, it has become a mainstream asset and one that has dragged the whole market with it. As a result, putting money into digital cash is something more and more people are looking into. With a market cap of around $3tn back in late 2021, you can see the appeal.
As with any kind of investment, though, it pays to know what you are doing first. A good place to start is looking at OKX cryptocurrency prices to get a feel for what the market is doing. This will help you make trading decisions, with the latest prices at hand to work from. Another thing to bear in mind is choosing exactly which coins to trade – with over 18,000 individual coins as of March 2022, this is not an easy task.
One option many investors are drawn to is stablecoins – but what are they and how do they work?
What are stablecoins?
In essence, these are certain types of coins that bridge the gap between fiat currency (such as the US dollar) and digital cash. The key thing to remember about them is that they are a lot more stable in terms of price than many other coins you could invest in.
Due to their value being based on more stable, sometimes tangible assets, these coins come with the reliability of fiat currencies but still have the utility and the mobility of cryptocurrencies.
Why are stablecoins popular with some investors?
Instability is not usually a good thing – look at the problems that rising inflation and energy prices are causing right now, for example. This is also true for investing in the world’s financial markets. This hints at the major reason these coins find favor with so many investors – their stability.
Anyone who knows the cryptocurrency market also knows it can be a highly volatile place at times. While some investors don’t mind this, it can be an issue for others who may be wary of getting involved. Stablecoins help solves this issue by giving traders coins that carry a lot less volatility. While this might mean the huge upswings seen in more volatile coins are off the table, it does offer a somewhat safer, less frenetic way to trade.
How do stablecoins work?
As noted previously, these coins work by using the backing they have to offer more stability in terms of price to investors. There are four major types of stablecoin to invest in – fiat-backed, commodity-backed, algorithmic, and crypto-backed.
Fiat-backed stablecoins (like TrueUSD) are linked on a 1:1 basis to a traditional fiat currency. This type of stablecoin is also known as “off-chain” because the collateral that underpins it is not another crypto asset. The fiat collateral backing stablecoins like this remains in proportion to the number of coins on the market and stays in the reserve of the issuer or their financial institution. As a result, the price remains a lot more stable.
“On-chain” stablecoins are those that are underpinned by other cryptocurrencies. In this process, online smart contracts are issued, rather than the collateral staying with a central offline issuer. This type of coin is seen as more stable because buyers are locked into a contract to purchase coins of an equal value. In addition, they are also usually over-collateralized to buffer against any price moves. DAI is perhaps the most popular example of this sort of stablecoin.
How do algorithmic and commodity-backed stablecoins work?
As you might expect, algorithmic stablecoins use a combination of special algorithms and smart contracts to carefully control the supply of specific tokens. When the coin in question falls below the price of the fiat currency it tracks, the algorithm will automatically reduce the number of coins in circulation to stabilize the price. The opposite will happen if the price of an algorithmic stablecoin exceeds the price of the fiat currency it follows. Ampleforth is perhaps the best-known algorithmic stablecoin around.
Commodity-backed stablecoins use actual physical commodities like oil or precious metals to collateralize themselves. PAX Gold, which uses gold as collateral, is a good example of this type of coin. Due to the volatility inherent in the commodity market, though, these stablecoins can vary most in price.
Stablecoins are a valuable tool for investors
Although the wild nature of the cryptocurrency market is a plus point for some, this volatility can actually put many others off. Due to this, stablecoins were created to help make the cryptocurrency world a more reliable, stable place to invest money.