What Are Stablecoins?

Last updated on 11/29/2018

A stablecoin is a type of cryptocurrency that is designed to hold a value pegged to something relatively stable, such as the U.S. dollar. The chief goal of stablecoins is to avoid the volatility and price swings that are common for cryptocurrencies like bitcoin and ether.

A stablecoin is not a specific cryptocurrency. The term instead refers to a class of cryptocurrencies that share price stability as a core function.

Why Are Stablecoins Valuable?

Stablecoins are useful because they provide a safe haven for cryptocurrency investors looking to exit a volatile environment.

Why is that important? Because traditionally, most cryptocurrencies have fluctuated widely in value due to changes in market demand. For example, in recent years bitcoin’s price on cryptocurrency exchanges has risen or fallen on a recurring basis by as much as 50 percent in just a few weeks’ time.

This means that the prices of bitcoin and most other cryptocurrencies have not been stable over a long period of time. If you convert $1,000 into bitcoin, there is a high chance that your bitcoin will not be worth the same price in dollars after a certain period of time.

Stablecoins aim to solve this problem by allowing investors to enter an asset that will hold its value over time without experiencing major increases or decreases in price.

Can Stablecoin Prices Change?

Yes. Stablecoins are not immune to price fluctuations. Their values can rise and fall. Compared with other cryptocurrencies, however, stablecoins typically experience much less price volatility. Stablecoins can fluctuate by a percent or so in either direction, but they are relatively stable compared with cryptocurrencies like bitcoin.

Stablecoins vs. Fiat Currency

Stablecoins are comparable to major fiat currencies, such as U.S. dollars or euros, which also offer relatively stable stores of value.

However, because stablecoins are cryptocurrencies, they offer features that fiat currency lacks, such as the ability to exchange currencies quickly between borders. Thus, you could say that stablecoins aim to give investors the best of both worlds: the stability associated with mainstream fiat currency and the flexibility of cryptocurrency.

How Do Stablecoins Work?

To date, several different strategies have emerged for designing stablecoins. Companies have employed different strategies, such as pegging the value of a stablecoin directly to fiat currency and controlling the price by regulating reserves of that stablecoin. Other stablecoin projects operate by maintaining a reserve of multiple assets including fiat and cryptocurrencies, using algorithms to balance the price of the underlying stablecoin.

Stablecoins vs. Other Cryptocurrencies

If other cryptocurrencies become more stable from a price perspective, stablecoins will lose their chief differentiator from other digital currencies. This does not mean that stablecoins will necessarily lose their value as well, but they might become a less important tool for investors.