Stable Coin
Kartavya Desk Staff
Source: FT
Context: Union Finance Minister stated that nations must “prepare to engage with stablecoins,” as innovations in cryptocurrency are reshaping global monetary systems and could force countries to adapt or risk exclusion.
About Stable Coin:
What is a Stablecoin?
• A stablecoin is a type of cryptocurrency that is specifically designed to maintain a stable value relative to a certain underlying asset, such as a basket of currencies or precious metals, but most commonly, a fiat currency like the U.S. Dollar.
• Unlike highly volatile cryptocurrencies (like Bitcoin), stablecoins aim for price stability, making them a more reliable medium of exchange within the blockchain universe and better suited for transactions.
Types of Stablecoins:
Stablecoins generally fall into two main categories:
• Fully Reserved Stablecoins: What it is: These are backed one-to-one by high-quality, liquid assets held in reserve by the issuer. How it works: Each coin issued is supported by an equivalent underlying asset, such as fiat currency or short-term government securities. This direct collateralisation helps to stabilize the price, as the holder theoretically has a guaranteed right to redeem the coin for the pegged asset at par value.
• What it is: These are backed one-to-one by high-quality, liquid assets held in reserve by the issuer.
• How it works: Each coin issued is supported by an equivalent underlying asset, such as fiat currency or short-term government securities. This direct collateralisation helps to stabilize the price, as the holder theoretically has a guaranteed right to redeem the coin for the pegged asset at par value.
• Algorithmic Stablecoins: What it is: These stablecoins are not backed by liquid reserves but are maintained by a set of automated rules. How it works: They use smart contracts (computerised algorithms) to respond to supply and demand imbalances. If the price trades above its peg, the protocol mints (creates) additional tokens to increase supply and drive the price down. If the price trades below its peg, the protocol burns (destroys) tokens to reduce supply and push the price back up.
• What it is: These stablecoins are not backed by liquid reserves but are maintained by a set of automated rules.
• How it works: They use smart contracts (computerised algorithms) to respond to supply and demand imbalances. If the price trades above its peg, the protocol mints (creates) additional tokens to increase supply and drive the price down. If the price trades below its peg, the protocol burns (destroys) tokens to reduce supply and push the price back up.
• If the price trades above its peg, the protocol mints (creates) additional tokens to increase supply and drive the price down.
• If the price trades below its peg, the protocol burns (destroys) tokens to reduce supply and push the price back up.
Key Features:
• Price Stability: They offer the low volatility necessary for commerce, remittances, and serving as a safe harbor for crypto investors.
• Efficiency: They enable fast and cheap transactions, especially for cross-border payments, bypassing traditional, slower, and costlier financial intermediaries.
• Programmability: As digital, on-chain assets, they can be integrated into smart contracts and automated financial systems, accelerating the movement of cash within financial services.
• Digital Fiat: They act as a digital, blockchain-based representation of fiat money, making them highly compatible with the traditional financial system’s need for real-time settlement.