How should stablecoins be understood? An in-depth analysis of the three main types and practical applications.

Stablecoins are a special type of token in the crypto market, characterized by their relatively stable prices. Unlike the highly volatile Bitcoin and Ethereum, stablecoins are pegged to fiat currencies like the US dollar and the euro or to precious metals, aiming to provide investors and traders with a hedging tool.

Why Do Stablecoins Exist?

In the crypto market, price fluctuation is the norm. Mainstream coins like Bitcoin (BTC) and Ethereum (ETH) can surge or plummet by 50% overnight, which poses significant challenges for daily trading and business settlements.

Imagine a café accounting in BTC - today selling 100 cups of coffee for 1 Bitcoin, and tomorrow Bitcoin drops by 50%, their revenue is halved. This uncertainty deters both businesses and users.

Stablecoins have emerged. Traders can quickly convert profits into stablecoins to lock in gains without having to withdraw to a bank account. Merchants can accept stablecoin payments without worrying about price risks. This tool combines the convenience of blockchain with the stability of fiat.

How do stablecoins maintain price stability?

The stability of stablecoins is achieved through three mechanisms:

fiat-collateralized stablecoin

This is the simplest and most direct way - for every stablecoin issued, 1 dollar (or equivalent fiat) is kept in a bank account as a reserve. TrueUSD (TUSD) adopts this model, allowing users to exchange dollars for TUSD at any time, and vice versa.

The advantage is high transparency, while the disadvantage is a high degree of centralization - the issuer of the stablecoin must genuinely hold these reserves.

encryption collateralized stablecoin

This stablecoin is backed by encrypted assets. Due to the significant fluctuations in the crypto market, it usually requires over-collateralization to hedge against risks.

Taking MakerDAO's DAI as an example: To generate 100 DAI, you need to submit 150 USD worth of Ether as collateral. This means your collateralization ratio is 150%. If Ether crashes and hits the liquidation line, your collateral will be automatically sold.

DAI automatically adjusts its supply through smart contracts: when the price falls below $1, the system encourages users to burn DAI in exchange for collateral, reducing supply; when the price exceeds $1, it encourages the creation of new DAI to increase supply. This game theory mechanism keeps the price fluctuating around the target.

algorithmic stablecoin

This is the most radical plan – no reserves backing it, entirely relying on algorithms to control the supply. When the price drops, the algorithm automatically destroys tokens or performs incentive operations; when the price rises, it increases the supply of new tokens.

It sounds very efficient, but in reality, it is difficult to maintain, and there are many failure cases. This type of stablecoin has the highest risk.

Advantages of Stablecoins

1. Suitable for daily trading

Stablecoins can be used like fiat, accepted by both merchants and users, while retaining the immediacy and global liquidity of blockchain. Cross-border remittances no longer require waiting for bank confirmations and can arrive in just a few minutes.

2. The convenience of blockchain native

Anyone can create a wallet (completely free) to receive and send stablecoins to any corner of the world. Transactions are irreversible, virtually eliminating the risk of fraud.

3. Portfolio Insurance

Holding a proportion of stablecoins can reduce overall risk. When the market is unclear, investors can quickly switch their positions to stablecoins to avoid risks and wait for opportunities to re-enter the market. This is much faster than frequently withdrawing to a bank account.

4. Convenient Leverage Tools

Traders can short with stablecoins - selling crypto assets at a high point for stablecoins and then buying back at a lower price after the price drops. All of this is done on-chain without leaving the exchange.

Risks of Stablecoins

1. Decoupling risk cannot be eliminated

Although mainstream stablecoins usually maintain a 1:1 price, not all projects can achieve this. Once a stablecoin loses its peg to the target asset, its price can depreciate significantly.

2. The authenticity of the reserve is difficult to verify

Not all stablecoin issuers publish complete third-party audit reports; most only release certification statements periodically. These certifications are issued by private accountants and may not necessarily reflect the true situation. Users must have sufficient trust in the issuer.

3. Centralized Risks

Fiat-collateralized stablecoins deposit reserves in banks, which means that issuers are subject to financial regulation and have strong control over the stablecoins. Once issuers face financial issues, the assets of holders are at risk.

4. Governance Risks of Decentralized Projects

Cryptocurrency collateralized stablecoins (such as DAI) are usually managed by a DAO (Decentralized Autonomous Organization) and require community voting decisions. If you do not actively participate in voting, you must trust the community to make the right decisions – but the community may not always be correct.

Real-World Stablecoin Cases

DAI: Representative of Encrypted Collateral

DAI is issued by the MakerDAO ecosystem and runs on Ethereum, pegged to the US dollar. Community members holding the MKR governance token can vote on project improvements. DAI uses over-collateralization and has a high degree of automation, but users need to understand its complex risk management mechanisms.

TrueUSD: A Model of Fiat-Collateralized

TUSD is pegged to the US dollar at a 1:1 ratio, with reserves independently held by banks. Each reserve can be verified at any time through a specialized verification mechanism (PoR), allowing users to confirm the sufficiency of funds themselves. This model is more transparent but more centralized.

The Regulatory Outlook for Stablecoins

Global regulators are increasingly focusing on stablecoins. They involve both the encryption and fiat domains, possessing dual attributes, which complicates regulation.

Some countries are attempting to issue official digital stablecoins (CBDC), hoping to gain the efficiency of blockchain while maintaining government control. In most regions, the issuance of stablecoins requires obtaining financial licenses, and the reserves must also comply with relevant regulations.

As a user, you need to understand the policy stance of your country regarding stablecoins and choose compliant projects.

Summary

Stablecoins have become an important infrastructure in the crypto ecosystem. Whether it's traders hedging against fluctuations, merchants accepting payments, or users making cross-border remittances, stablecoins provide practical solutions. However, they are not completely risk-free—issues such as insufficient reserves, decoupling events, and issuer bankruptcy have occurred.

Before using any stablecoin, it is essential to research its mechanisms, reserve status, and the background of the issuer. Diversify your investments and do not stake all your funds on a single stablecoin. Remember, even stablecoins are essentially crypto assets and carry corresponding risks. Do your homework to navigate this market safely.