🪙 What are stablecoins and how do they work

Stablecoins are cryptocurrencies whose value is pegged or tied to that of another currency, commodity, or financial instrument, such as the US dollar, EUR, or gold

🪢 The main purpose of a stablecoin is to remain "pegged" to the underlying asset it represents. The difference between stablecoins is how they maintain the peg and how they are issued.

There are three types of stablecoins:

🔹 Fiat-collateralized. These types of stablecoins use currency reserves and other collateral options to make them redeemable for USD, usually, it's short-term treasuries and corresponding fiat currencies. Examples of such stablecoins are USDT and USDC.

🔹 Crypto-collateralized. These types of stablecoins are backed by crypto. To ensure stability, they are overcollateralized, meaning the reserve's value exceeds the stablecoins issued. An example of such a stablecoin is LUSD which is backed by ETH.

🔹 Algorithmic. The algorithmic stablecoins do not always rely on any reserves. To maintain stability, they use programmed formulas and are often paired with another asset which is colotile and tied to the stablecoin itself. An example of algorithmic stablecoin is the infamous UST in pair with LUNA altcoin.

There are also mixed stablecoins. FRAX stablecoin is crypto-collateralized and algorithmic at the same time. DAI stablecoin was crypto-collateralized, but recently MakerDAO added US Treasuries to the stablecoin reserves.

Stablecoins can also be centralized or decentralized:

🏦 Centralized stablecoins are issued and maintained by a central authority or institution, such as a Circle company that issues USDC.

🌐 Decentralized stablecoins operate on the blockchain network without a central authority, examples of such stablecoins are FRAX, LUSD, and DAI.

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