Stablecoins
An introduction to what stablecoins are, their main types, and their functions.
What Are Stablecoins?
Stablecoins are a type of cryptocurrency created by financial institutions, banks, exchanges, insurers, government entities, and other organizations. Unlike more volatile cryptocurrencies such as Bitcoin (BTC) and Ethereum (ETH), stablecoins are designed to minimize price fluctuations by pegging their value to stable assets—such as the U.S. dollar, gold, or a basket of fiat currencies.
Key Functions of Stablecoins
- Store of Value and Medium of Exchange: In the highly volatile crypto market, stablecoins provide a safe haven. Users can convert their assets into stablecoins during market downturns to preserve value. They also serve as a convenient medium of exchange, avoiding the complexities and high fees associated with converting back to fiat.
- Bridging Traditional Finance and Crypto: Stablecoins act as a crucial gateway between fiat currencies and the crypto ecosystem. They allow users to seamlessly move between traditional money and digital assets.
- Powering Decentralized Finance (DeFi): Stablecoins are fundamental to the DeFi ecosystem. They are widely used in lending, liquidity mining, derivatives trading, and as a unit of account, providing stability across various financial protocols.
- Efficient Cross-Border Payments: Blockchain-based stablecoins enable fast, low-cost international transfers (e.g., using Spell Pay) without relying on traditional banking systems, significantly improving the efficiency of global transactions.
Main Types of Stablecoins
Based on their collateral structures, stablecoins are generally categorized into three types:
- Fiat-Collateralized: Issued by centralized entities that hold equivalent reserves in fiat currency (e.g., U.S. dollars). Examples: USDT (Tether), USDC.
- Crypto-Collateralized: Backed by over-collateralized cryptocurrency holdings (e.g., ETH) and stabilized through smart contracts and algorithmic mechanisms. Example: DAI.
- Algorithmic Stablecoins: Not backed physical assets; instead, they use algorithms and smart contracts to control supply and demand to maintain price stability. These carry higher risks and have experienced multiple de-pegging events. They are currently not recommended for use.
Risks and Challenges
Despite their utility, stablecoins face several challenges, including credit risk from centralized custodians, lack of collateral transparency, regulatory uncertainty, and the potential failure of algorithmic mechanisms under extreme market conditions.
You can refer to Spell’s list of supported stablecoins, which have been evaluated and meet Spell’s compliance standards.