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What Are Crypto Dollars or Stablecoins?

Stablecoins are a safe harbor in the sea of typical cryptocurrency unpredictability. Learn everything you need to know about them in this post. 

Cryptocurrency is supposed to be revolutionary, and it is. But it’s also infamously unstable. It often reaches dizzying heights one day and plummets to gut-wrenching depths the next. Needless to say, the huge volatility doesn’t exactly inspire customer confidence.

Traditional cryptocurrency like Bitcoin or Ether isn’t backed by collateral. This is partly the reason why it fluctuates in value substantially. Stablecoins, however, are backed by assets. It makes them less mercurial. Usually, stablecoins are backed by currency like the U.S. dollar. But they can also be collateralized by other assets like real estate, gold, or even other cryptocurrencies.

Enter stablecoins – the rock-steady digital asset

But not all cryptocurrencies are unstable. Some of them have their value pegged to stable real-world assets, such as the U.S. dollar. Because 1 U.S. dollar is always 1 U.S. dollar, these digital assets have value that is tied to the underlying asset it tracks. 

As these digital assets are stable in nature, they’re dubbed stablecoins. Stablecoins offer a less speculatory and more practical alternative to traditional crypto.

Stablecoins are backed by collateral

Traditional cryptocurrency like Bitcoin or Ether isn’t backed by collateral. This is partly the reason why it fluctuates in value substantially. Stablecoins, however, are backed by assets. It makes them less mercurial. Usually, stablecoins are backed by currency like the U.S. dollar. But they can also be collateralized by other assets like real estate, gold, or even other cryptocurrencies. 

Depending on the collateral backing them, stablecoins are divided into three categories: 

1. Fiat-collateralized stablecoins

Fiat-collateralized stablecoins are backed by money issued by governments. This includes currencies like the USD, EUR, or GBP. As long as the economy of the currency’s country remains stable, so will fiat-backed stablecoins. Tether (USDT) and USD Coin (USDC) are two popular examples.  

Fiat-backed stablecoins are collateralized 1:1. That means for every stablecoin in circulation, a single unit of currency ($1) is kept in a bank account to back it up. If you want to trade in your stablecoin for cash, you will receive the equivalent directly from the issuer, such as Circle for the USDC stablecoin, or purchase it on a crypto exchange like Coinbase. The stablecoins corresponding to the amount you retrieved will be taken out of circulation if you redeem it with the issuer.

2. Commodity-collateralized stablecoins

Commodity-collateralized stablecoins are backed by commodities. Some examples of assets as collateral include oil, gold, and other precious metals. Digix Gold (DGX) is a popular stablecoin backed by gold. It is issued on the Ethereum blockchain

Owning a digital asset backed by commodities as collateral has some advantages. If the commodity appreciates over time – as is often the case with gold – then so will the stablecoin pegged to it. It is faster and cheaper to purchase and settle stablecoins than securities backed by commodities. 

3. Crypto-collateralized stablecoins?

Crypto-collateralized stablecoins have other cryptocurrencies backing them. Their value is soft pegged to 1 U.S. dollar. A prime example is DAI, the stablecoin backed by the cryptocurrency Ether (ETH). DAI has a lot of potential and is only rising in popularity, especially among the DeFi community. We’ll cover DAI in-depth in the next post.

How can a digital asset backed by cryptocurrencies be stable in value? It’s possible because of the over-collateralization – meaning that there must always be more cryptocurrency backing a stablecoin – incentivization, and collateral management mechanisms built into the system. That means a stablecoin pegged at $100 in value is often backed by $150-$400 worth of cryptocurrency like Ether. The value in excess of $100 offers a buffer against price drops and the market volatility of Ether. 

Some stablecoins are non-collateralized

Some rare stablecoins are non-collateralized. They are algorithmically derived and managed. But isn’t that a paradox? How can they remain stable in value without collateral? The U.S. dollar was once backed by gold, but it’s not anymore. It has value because everyone believes in its value. The same principle is applied to non-collateralized stablecoins. 

Non-collateralized stablecoins are experimental and not as reliable as other stablecoin types. Supply and demand determine the value of non-collateralized stablecoins. When demand is up, new stablecoins are introduced. When demand is low, stablecoins are taken away from the pool. This keeps the value relatively stable. Computer algorithms govern the available pool of non-collateralized stablecoins.

Stablecoins offer several advantages

Why should you use stablecoins? They have several applications and much to offer: 

  • Stablecoins are fast and much more cost-efficient to move on blockchains than money since transactions involving stablecoins are immutable and settle almost instantaneously. 

  • They are accessible to anyone in the world with an internet connection. 

  • They’re programmable and have several uses – payment for goods and services, peer-to-peer payments, remittances, investments, and more. 

  • They offer an alternative way of earning yield. 

Linen App utilizes crypto dollars (USDC)

Linen App allows you to turn your real-world dollars into crypto dollars – USDC stablecoin to be specific – and deposit them to the Compound Liquidity Pool. USDC is pegged 1:1 to the U.S. dollar. You can participate in Decentralized Finance (DeFi) and earn interest on your USDC dollars on Compound through Linen App. 

Stablecoins are… useful

Stablecoins inherit all the strengths of cryptocurrency, namely programmability, fast settlement times, and immutable records, as well as a few of their weaknesses. Cryptocurrencies like Bitcoin have been floundering recently, but stablecoins are bucking the trend and rising in value instead. In April 2020, over $9 billion worth of U.S.-dollar-denominated stablecoins are in circulation globally. We may see stablecoins explode in popularity soon.