Understanding Stablecoins: A Beginner’s Guide to Stable Cryptocurrencies

7 min readOct 13, 2023

Cryptocurrencies have changed the traditional world of finance to the extent that regulators are now working to create a framework around this emerging concept of cryptocurrencies and the blockchain.

Simply put, cryptocurrencies introduce decentralized digital assets that can be used as stores of value just as you would regular cash, yet, unlike traditional money, cryptocurrencies are not controlled by any central authority.

While the most well-known cryptocurrency, Bitcoin, is famous for its price volatility, there exists a class of digital assets called stablecoins that aim to provide stability in an otherwise volatile crypto market.

This article will explore the concept of stablecoins and discuss some of the main stablecoins available today.

What is a Stablecoin?

A stablecoin is a cryptocurrency designed to maintain a stable value, typically pegged to an external asset or a basket of assets.

Unlike traditional cryptocurrencies like Bitcoin or Ethereum, which can experience significant price fluctuations, stablecoins aim to mitigate volatility by offering a reliable store of value and medium of exchange.

Stablecoins achieve stability through various mechanisms. Some are backed by traditional assets, such as fiat currencies (like the US dollar or the euro), while others use algorithms or smart contracts to maintain a stable value. These features make stablecoins an attractive option for those who seek to use cryptocurrencies for everyday transactions or as a hedge against market volatility.

Main Types of Stablecoins:

Fiat-Collateralized Stablecoins:

Fiat-collateralized stablecoins are backed by traditional currencies, such as the US dollar or the euro, held in reserve by the issuing entity. For every unit of stablecoin in circulation, an equivalent amount of fiat currency is held in reserve. These stablecoins offer stability since their value is directly tied to the underlying fiat currency.

Tether (USDT) and USD Coin (USDC) are prominent examples of fiat-collateralized stablecoins. These stablecoins are often used for trading on cryptocurrency exchanges and are widely accepted in the crypto community.

Crypto-Collateralized Stablecoins:

Crypto-collateralized stablecoins are backed by other cryptocurrencies, usually held in excess of the value of the stablecoins issued. These stablecoins maintain stability through over-collateralization, ensuring that the value of the collateralized assets is higher than the stablecoin supply.

Dai (DAI), an Ethereum-based stablecoin, is a well-known example of a crypto-collateralized stablecoin. It uses a decentralized lending platform called MakerDAO to manage its stability.

Algorithmic Stablecoins:

Algorithmic stablecoins use smart contracts and algorithmic mechanisms to maintain a stable value without any collateral backing. These stablecoins often rely on supply control and price feedback mechanisms to regulate their value.

Ampleforth (AMPL) is an example of an algorithmic stablecoin that adjusts its supply based on demand, aiming to keep the price stable over time. However, it’s important to note that algorithmic stablecoins can still be subject to some degree of volatility.

How to use a stablecoin

Now that you know what stablecoins are, let’s look at how you can use them to your benefit. Here is a quick guide.

Step 1: Choose a Stablecoin:

Before diving into using stablecoins, it’s important to select the right one based on your needs. As mentioned, different stablecoins are available, such as fiat-collateralized, crypto-collateralized, and algorithmic stablecoins. Be sure to conduct research and select a stablecoin that aligns with your preferences and the use case you have in mind.

Step 2: Obtain Stablecoins:

To use stablecoins, you need to acquire them. The methods of obtaining stablecoins may vary depending on the stablecoin you choose. Here are a few common ways:

a. Exchanges:

Most stablecoins can be purchased on cryptocurrency exchanges. Sign up for a reputable exchange that supports your desired stablecoin and follow the platform’s instructions to buy stablecoins using fiat currency or other cryptocurrencies. Stablecoins such as USDT come with negligible fees, so you should have an easy time moving your stablecoins from wallet to wallet.

b. Peer-to-Peer (P2P) Platforms:

Some stablecoins can be obtained directly from other individuals through P2P platforms. These platforms facilitate direct transactions between buyers and sellers, providing an alternative to traditional exchanges.

c. OTC Markets:

Over-the-counter (OTC) markets cater to larger trades and can be useful for acquiring significant amounts of stablecoins. OTC markets connect buyers and sellers directly and typically involve negotiating prices with a counterparty.

Step 3: Wallet Selection:

Once you have acquired stablecoins, you’ll need a secure wallet to store them. There are various types of wallets available, including:

a. Software Wallets:

These wallets can be downloaded and installed on your desktop or mobile device. They offer convenience and accessibility but require precautions such as regular backups and secure device management.

b. Hardware Wallets:

Hardware wallets are physical devices that store your stablecoins offline. They provide a high level of security by keeping your private keys away from internet-connected devices. Consider investing in a hardware wallet if you plan to hold a significant amount of stablecoins.

c. Custodial Wallets:

Certain exchanges and platforms offer custodial wallets that store stablecoins on your behalf. While convenient, custodial wallets place trust in the platform’s security and control over your funds.

Step 4: Transacting with Stablecoins:

Now that you have stablecoins in your wallet, you can start utilizing them for various purposes:

a. Sending and Receiving:

Like traditional cryptocurrencies, you can send stablecoins to other individuals or businesses using their wallet addresses. Simply initiate a transaction from your wallet and input the recipient’s address along with the desired amount of stablecoins.

b. Trading and Investments:

Stablecoins can be used for trading on cryptocurrency exchanges. You can pair stablecoins with other cryptocurrencies or trade them for fiat currencies. Additionally, stablecoins are often used as a stable asset for diversifying cryptocurrency investments during market volatility.

c. Payments and Remittances:

Many merchants and online platforms accept stablecoins as a form of payment. Look for businesses that explicitly support stablecoin payments or explore payment processors that facilitate stablecoin transactions.

Step 5: Stay Informed and Secure:

As with any digital asset, staying informed and practicing good security measures when using stablecoins is crucial. Be sure to keep track of news and developments in the stablecoin ecosystem to understand any updates, regulations, or new use cases. This knowledge will help you make informed decisions and navigate the evolving landscape effectively.

Conclusion:

Stablecoins provide a valuable bridge between traditional finance and the world of cryptocurrencies. By offering stability and predictability, stablecoins enable individuals and businesses to engage in digital currency transactions without being subject to the wild price swings associated with other cryptocurrencies.

Whether you’re a crypto enthusiast, a trader, or someone new to the world of cryptocurrencies, understanding stablecoins is essential. They provide a gateway to more practical and reliable use of digital currencies, and their popularity continues to grow as they gain wider acceptance across various industries.

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Disclaimer: Not financial advice. Cryptocurrency and blockchain investments are high risk, can incur substantial losses, and are not suitable for everyone. Please consult a professional before considering investment in any cryptocurrency. This article does not encourage or support any specific investments, use of applications or technology, or financial direction. This article is for informational purposes only and should be verified and validated externally for 100% accuracy.