What are Stablecoins?

Stablecoins are a type of cryptocurrency programmed to track the value of another asset like government monies or gold.

Many investors are drawn to stablecoins because they offer the efficiency and transparency of cryptocurrencies, while providing relief from the sometimes extreme volatility of these assets. 

However, traders and investors should note that not all stablecoins are created equal. 

As of 2020, there are two main classes of stablecoins, fiat-collateralized stablecoins and crypto-collateralized stablecoins, both of which are available on exchanges like Kraken. 

Still, stablecoins come in a wide range of varieties. By some counts, there are over 200 active stablecoin projects, which together process more volume than even Venmo, PayPal’s mobile peer-to-peer payments platform,

Not sure where to begin with this crypto asset class? Below we explain how stablecoins work and why they might be a compelling addition to your crypto asset portfolio.

All stablecoins seek to mimic the price of another asset, but they don’t all accomplish this in the same way. This means that some stablecoins may be riskier than others and more prone to the price fluctuations they claim to provide safety from. 

Fiat-Collateralized Stablecoins

Fiat-collateralized stablecoins are cryptocurrencies backed 1-to-1 by an underlying government currency (like USD or EUR) stored in a traditional financial institution.  

This type of stablecoin was first introduced in 2014 when startup Tether Limited released USDT, a dollar-backed cryptocurrency designed to trade 24/7 on the global crypto market. As of 2020, Tether remains the most widely used stablecoin around the world.

Like USDT, fiat-collateralized stablecoins are generally managed by a central operator, who tracks their circulation and allows users to mint and redeem tokens in their custody. 

In some cases, these reserves are even regularly audited to ensure that the amount of tokens traded is equal to the reserves held by the firm.

Examples of fiat-collateralized stablecoins include USDT and USDC (pegged to the USD).

Crypto-Collateralized 

Crypto-collateralized stablecoins are collateralized by one or more cryptocurrencies.

These assets generally lack a central administrator, and instead rely on an open software to enable borrowers to lock crypto assets (thus collateralizing them) and generate new stablecoins in the form of loans.

To account for the volatility of the underlying cryptocurrency, these stablecoins are often over collateralized, meaning that the deposit amount required is typically a higher percentage than the value of the stablecoin. 

If borrowers wish to redeem their locked cryptocurrencies, they have to return the stablecoins to the protocol and pay a fee. 

Due to their design, the stablecoin supply cannot be altered by anyone in the network. Instead, contracts are programmed to respond to changes in the market price of the locked assets.

Examples of crypto-collateralized stablecoins include DAI, Havven, and BitUSD.

Algorithmic Stablecoins

Algorithmic stablecoins are digital assets that rely on smart contracts to regulate their stability. 

Rather than using deposits of cryptocurrencies or issuing and redeeming debt, the software behind algorithmic stablecoins programmatically adjusts the supply of the cryptocurrency as the demand for it fluctuates. 

If demand is high, the price of each stablecoin will exceed the intended peg, and the software will increase the supply. Alternatively, if demand is low, the supply will decrease. 

Examples of algorithmic stablecoins include Ampleforth and Yam.

Users may be interested in purchasing stablecoins as they offer all the benefits of traditional cryptocurrencies, such efficiency and transparency, while protecting from price volatility. 

Further, like other cryptocurrencies, they are borderless, programmable and easy to transfer at low cost, offering a valuable alternative to traditional banking institutions. 

Kraken users can quickly transfer supported stablecoins DAI and USDT to their accounts and exchange them for other cryptocurrencies. 

Now you're ready to take the next step and buy some cryptocurrencies!