A stablecoin is a novel category of cryptocurrencies whose value is equal to an asset it seeks to emulate or peg to, which is typically the US dollar. A stablecoin is backed by a reserve asset and is designed to remain relatively stable, enabling cryptocurrency holders to perform daily transactions in the extremely volatile crypto market without the high risk of massive price swings.

There are three types of stablecoins:

  • Fiat-backed
  • crypto-backed,
  • and algorithmic stablecoins

Fiat-backed or fiat-collateralized stablecoins are cryptocurrencies backed by underlying fiat reserves in banks, such as Tether (USDT), USD Coin (USDC), and TrueUSD (TUSD).

Crypto-collateralized stablecoins are crypto-assets backed by other cryptocurrencies. In order to cushion against the volatility of its underlying tokens, crypto-collateralized stablecoins maintain a larger reserve of said assets, a scheme commonly referred to as “over-collateralization.” One phenomenal example is MakerDAO’s DAI, which utilizes a set of various digital coins such as ETH, REP, BAT, as its collateral.

Lastly, algorithmic stablecoins are designed to function as a decentralized digital bank, minting or burning tokens as needed in order to control supply. Instead of having asset reserves, algorithmic stablecoins are backed by smart contract programs. These contracts automate the process of minting and burning, with no authority figure having arbitrary control over its system. Some of the most popular algorithmic stablecoins include Ampleforth (AMPL) and Mith Cash (MIC).

Stablecoins may also be backed by commodities such as gold, silver, or oil, but they are usually still pegged to the US Dollar.