Let’s say you’re shopping for shoes. On Thursday, you see exactly the pair you have been looking for. The price is 50 euros. You return to the shop after work to buy them, only to find the price is now 100 bucks. What gives?
The shopkeeper may have raised the price. But if your bucks are cryptocurrencies, it is just as likely that your digital funds have diminished in value. Cryptocurrencies are notoriously volatile, and the amount you need to buy a pair of shoes may get you three pairs next week – or no pairs at all.
This volatility complicates commerce. If you’re looking to buy real-world goods with cryptocurrency – or to exchange crypto coins and tokens for euros or dollars to make a purchase – then you can never be quite sure what you’ll pay.
That’s where stablecoins come in. The stablecoin was invented to deliver most of the benefits of cryptocurrencies while avoiding the disadvantages of price volatility. The value of stablecoins is stable, meaning the price doesn’t have wild fluctuations in the face of supply and demand.
Among the most widely used stablecoins are Tether (USDT), True USD (TUSD), Paxos Standard (PAX), USD Coin (USDC), Binance USD (BUSD), and Goldcoin (GLC).
The value of a stablecoins is determined by the issuer of the coin. Stablecoins may be backed by fiat currency, by other cryptocurrencies, or by commodities like gold. A few cryptocurrency issuers stabilize prices by manipulating the supply of tokens available to purchasers. When the supply exceeds demand, the price of the token drops. When tokens are scarce, the price rises.
The most widely used stablecoins are backed by fiat currency, typically the U.S. dollar. The issuer owns a reserve of dollars – one actual dollar for each coin that is worth $1. This gives each of the coins a real value, because the issuer will buy and sell the tokens at that price. In practice, supply and demand cause small fluctuations in the price of even the best stablecoin, but prices are much more stable than they are for traditional cryptocurrencies like Bitcoin and Ether.
The relatively predictable conversion rate of stablecoins to fiat currencies and commodities makes stablecoins good candidates for decentralized finance applications that handle both crypto and fiat currencies.