Stable digital assets: how they work and why it matters

Stablecoins are cryptographic coins linked to stable assets such as fiat currencies or precious metals. They create a bridge between the volatile world of cryptocurrencies and the need for price stability. There are three main types: fiat-backed, crypto-backed, and algorithmic. Today, stablecoins occupy a central place in the blockchain ecosystem, attracting the attention of not only investors but also government regulators.

Why Stable Coins Solved the Volatility Problem

Bitcoin (BTC) and Ethereum (ETH) have shown significant price fluctuations since their inception. For speculators, this opens up opportunities, but it creates enormous problems for practical use.

Imagine a coffee shop that accepts payments in cryptocurrency. Today, coffee costs $5 in BTC, but tomorrow the received coins lose 50% of their value. Such fluctuations make it impossible to plan the business and manage revenues.

Stable coins have resolved this dilemma. They allow traders to lock in profits and losses without converting assets back into traditional currencies. At the same time, they provide the ability to use cryptographic networks for transferring funds at a fixed cost.

Pegging Mechanism: How Stable Coins Maintain Price

Various mechanisms are used to maintain the peg to the target asset. Each approach has its strengths and weaknesses, but none provides an absolute guarantee.

Monetary Provision

Stablecoins of this type have reserves of traditional currencies (USD, EUR, GBP). Each coin is backed by a real deposit at a ratio of 1:1. For example, one TUSD is guaranteed by one dollar.

Users can freely convert fiat to coin and back at a fixed rate. This creates a simple and clear mechanism, but requires a high level of trust in the issuer.

Cryptographic Support

Here, another cryptocurrency serves as collateral. Since the crypto market is extremely volatile, such stablecoins use over-collateralization to protect against the decline in the collateral price.

Smart contracts manage the creation and burning of coins, ensuring transparency. Users can independently verify the logic of the contract. However, many such projects are organized as decentralized autonomous organizations (DAO), where the community votes on changes.

Let's take DAI as an example. To create 100 DAI, you need to deposit cryptocurrency worth $150 as collateral with 150% collateralization (. The obtained coins can be used for any purposes: trading, investing, storing.

When the price of DAI falls below $1, holders are motivated to redeem coins for collateral, which reduces supply and raises the price. If the price exceeds $1, users are incentivized to create new tokens, increasing supply and lowering value.

The system uses game theory and algorithms to maintain equilibrium. If the collateral falls below the minimum ratio, it is automatically liquidated.

) Algorithmic Management

This is the rarest and most complex variant. Algorithmic stablecoins do not hold currency reserves. Instead, program codes and smart contracts control the issuance and destruction of coins.

When the price falls below the target level, the system reduces supply through fixed staking, burning, or repurchasing coins. If the price rises above the target level, new coins are issued into circulation to lower the cost.

Practical applications of stablecoins

Daily Payments

Stable value makes stablecoins suitable for regular transactions. Unlike volatile altcoins, such coins can be used for purchases and transfers without the fear of sharp depreciation.

Advantages of Blockchain

Since stablecoins operate on distributed networks, they can be sent to compatible crypto wallets ### created in seconds and for free (. The system virtually eliminates double spending and counterfeit transactions. This opens up new opportunities for various applications.

) Portfolio Hedging

Traders and investors often allocate a portion of their portfolio to stablecoins. This reduces overall risk and protects against market fluctuations, while also allowing for quick responses to advantageous purchases.

You can also sell volatile assets for stablecoins during a market downturn and buy them back at lower prices later - a process known as shorting. Stablecoins allow you to enter and exit positions without withdrawing funds from the blockchain.

Risks and Limitations

Problems with binding

Not all projects manage to maintain the peg. If a stablecoin consistently deviates from its target price, it may sharply decline in value. History has seen several cases of ambitious projects crashing.

Lack of Transparency

Many stablecoins do not publish full audits. Instead, only regular attestations are provided by private auditors on behalf of the issuers. This is insufficient for a complete verification of reserves.

Centralization

Fiat-collateralized stablecoins are more centralized than other crypto-assets. The collateral is held by a single entity, which is subject to financial regulation. This gives it significant control. Users are forced to trust that the issuer actually has the declared reserves.

Community Dependence

Crypto-collateralized and algorithmic stablecoins rely on community governance. Users either participate in votes or trust the developers. This can lead to poor decisions.

Real Examples in the Market

DAI is one of the most successful crypto-collateralized stablecoins on the Ethereum blockchain. It is pegged to USD and governed by the MakerDAO community through the MKR governance token. It uses over-collateralization and is managed by smart contracts without intermediaries. Users open collateralized debt positions to manage their collateral.

TUSD is an independent verifiable stablecoin pegged to the dollar. It is the first to programmatically manage issuance with instant verification of USD reserves. The reserves are verified through the Proof of Reserves ###PoR( mechanism of the Chainlink network, allowing users to autonomously confirm that each coin is fully backed by dollars.

Regulatory Framework

Stablecoins attract the attention of regulators worldwide. The reason is simple: they combine fiat currencies with crypto technology and can be used not only for speculation but also for carrying out cheap international transactions.

Some countries are experimenting with their own stablecoins. According to the legislation of most jurisdictions, stablecoins are considered cryptocurrencies and are subject to the relevant regulations. The issuance of fiat-backed variants often requires approval from financial regulators.

Final Thoughts

Stable coins have become an integral part of the crypto ecosystem. Traders store them on exchanges for quick transitions between trading pairs. Investors use them for hedging. Businesses apply them for payments and cross-border transfers.

However, it would be a mistake to underestimate the risks. Some projects have lost their peg, depleted reserves, or faced lawsuits. Despite their universality, stablecoins remain crypto assets with all the inherent risks.

To minimize losses, it is recommended to diversify your portfolio and conduct your own research before any operations with digital assets.