What are stablecoins?
Cryptocurrency has a reputation for being rather volatile when compared to other currencies. I am sure you have heard about the 10-20% price swings that occur in a few days. If this makes you squeamish, you are not alone; most of my cryptocurrency portfolio is in stablecoins.
Stablecoins are tied to the value of other more stable assets, usually fiat currencies.
Fiat backed stablecoins
The issuing entity of a particular stablecoin creates a reserve where it securely stores the fiat backing the stablecoin; for example, dollars in a brick and mortar bank. A stablecoin user can redeem one unit of a stablecoin for one unit of the fiat that backs it.
The question then becomes, do you trust the issuer to keep a sufficient reserve, or is the issuer playing games like modern banks? Only keeping a fraction of the issued stablecoins collateralized; unauthorized fractional reserve banking. I stay away from Tether/USDT after they continue to be embroiled in such scandal: https://ag.ny.gov/press-release/2019/attorney-general-james-announces-court-order-against-crypto-currency-company
At time of publishing this course, there are no euro stablecoins because euro stablecoin issuers cannot make money when euros have a negative interest rate.
Asset backed stablecoins
The next most complex type of stablecoin is collateralized by other cryptocurrencies (or on-chain assets – art, homes, contracts) rather than fiat yet still is engineered to track a mainstream asset like the dollar. The current front-runner is MakerDao’s DAI.
Much like fiat currencies themselves, no collateral backs these stablecoins. Instead, coins are either burned or created to keep the coin’s value in line with the target price. Say the coin drops from the target price of $1 to $0.75. The algorithm will automatically destroy a swathe of the coins to introduce more scarcity, pushing up the price of the stablecoin. Computers do essentially the same thing central bankers do in this stablecoin model.