4 Types of Stablecoins | How to Choose and Don’t Make a Mistake

Stablecoins are a critical element of the financial ecosystem of the cryptocurrency market. Their methodology was first developed in 2012 based on the traditional blockchain. Two years later, the first stable cryptocurrency appeared, becoming USD Tether.

Stablecoins have been the focus of crypto enthusiasts for the past 8 years. Many cryptocurrency market participants believed that the model of pegging stablecoins to fiat money or other assets was very reliable and unbreakable.

However, the situation with the collapse of the UST algorithmic stablecoin in the spring of 2022 proved otherwise. Many crypto experts, investors, and ordinary users started to study stablecoin technology in more detail, trying to identify potential risks for seemingly reliable projects.

We have analyzed all types of stablecoins in detail. This article will help you learn the advantages and disadvantages of each types of cryptocurrency so as not to make a mistake and choose the most reliable crypto asset.

Features of Stablecoins as an Element of the Crypto Market

Stablecoin is a cryptocurrency whose exchange rate is fixed against to fiat currency and secured by an asset. It is customary to keep considerable savings in stablecoins to easily exchange them for dollars and avoid significant losses in asset value as the exchange rate fluctuates.

The creators of the world’s first stablecoin created a digital coin whose exchange rate is ensured by the U.S. economy and banking policies, giving it more excellent stability than pure “crypto”. It is stored using blockchain protocols that guarantee security, anonymity, and decentralization on a par with other traditional cryptocurrencies.

Each types of stablecoin has a unique fixed exchange rate support system. This determines the stability of the exchange rate during market volatility, resistance to hacking, and security in general.

As it turns out, some stablecoins cannot withstand external threats.

Therefore, when choosing a stable coin, it is important to consider its technical parameters and operation algorithm. Its stability and reliability depend on it. After all, some algorithms, as it turned out, cannot provide a fixed rate.

Let’s understand the types of stablecoins, their disadvantages, and their advantages in more detail.

4 Types of Stablecoins

There are four main types of cryptocurrency stablecoin.

Fiat-backed

Fiat-backed stablecoins are 100% backed by fiat currencies (the U.S. dollar or other non-inflationary currencies). This means that the maker of these stablecoins has a reserve fund equal to the number of coins in circulation. If there is a slight change in the price of a coin, money from the fund is used to stabilize the exchange rate.

Unlike other cryptocurrencies, which fluctuate wildly in value, stablecoins with fiat backing tend to have very small price fluctuations. But that doesn’t mean that Stablecoins are a completely safe bet. They are still relatively new, with a limited track record and unknown risks. Nevertheless, fiat-backed coins are considered the safest because their monetary funds allow you to react quickly to market fluctuations and stabilize the exchange rate.

Examples: USDC (Coinbase), USDT (Tether), BUSD (Binance).

Pros

• 100% covered by the reserve money fund
• Rate changes are minimal even with high market volatility

Cons

• Exposed to the risk of fiat currency inflation from the reserve fund

Trustee Wallet gives users complete access to USDT as one of the most popular fiat-backed stablecoins. You will be surprised by the wide choice of coins to exchange and the possibility of profitable deposits and withdrawals of cryptocurrency using this crypto wallet.

Crypto-backed

Crypto-backed stablecoins are backed by other crypto-assets. Because the backup asset can be unstable, these stablecoins have collateral with a margin to guarantee the coin’s value even when the market is highly volatile. For example, a $1 cryptocurrency stablecoin may be tied to a base crypto-asset worth $2. Therefore, if the underlying cryptocurrency loses value, the stablecoin has a built-in safety cushion and can remain at $1. These assets are less stable than fiat-backed stablecoins, and keeping an eye on how the underlying crypto-asset behind your stablecoin performs is advisable.

Example: DAI, which is pegged to the U.S. dollar and runs on the Ethereum blockchain (also available in Trusree Wallet).

Pros

• Have absolute collateral of crypto assets in the amount exceeding the capitalization of stablecoin

Cons

• Cryptocurrency collateral coins have high volatility and can be devalued

Commodity-backed

Stablecoins backed by commodities uses gold, platinum, copper, and securities to maintain their value. These stablecoins are centralized, which part of the cryptocurrency community may see as a drawback, but it also protects them from cryptocurrency volatility. Gold has long been a hedge against stock market volatility and inflation, making it an attractive addition to portfolios in fluctuating markets. As a rule, such coins have up to 100% of their capitalization backed by raw materials or securities.

Example: Digix (a gold-backed stablecoin).

Pros

• Secured by stable raw materials and securities

Cons

• Raw materials, precious metals, and securities may be depreciating
• Raw materials, precious metals, and securities are less convenient as a reserve fund because they take longer to sell or replenish

Algorithmic

Algorithmic stablecoins are not backed by any assets, making them difficult to understand. These stablecoins use a computer algorithm so that the value of the tokens does not fluctuate too much. If the price of an algorithmic stablecoin is pegged at $1, but the Stablecoin goes higher, the algorithm will automatically release more tokens into supply to bring the price down. If it falls below $1, it will reduce the supply to raise the price again. The number of tokens you own will change, but they will still reflect your stake.

Example: UST stablecoin depreciated in May 2022 due to algorithm malfunction and other factors. Therefore, trust in this types of cryptocurrency stablecoin has declined.

Pros

• Anyone can create it without a reserve fund

Cons

• May devalue, as real assets do not secure them

Conclusion: Best Type of Stablecoins

There are several stablecoin types, but the most secure ones are backed by different real assets: fiat money, gold, and securities.

The safest coins are considered stable coins with 100% reserve to cover any fluctuations in exchange rates and high volatility of the crypto market. Such stablecoins include Tether (USDT), USD Coin (USDC), and Binance USD (BUSD). Coins with 100% cryptocurrency collateral like DAI also deserve your attention. At the same time, algorithmic stablecoins like USDD have higher risks.

Adhere to the rules of cryptocurrency portfolio diversification to minimize any risks. This will help you form a protected capital in a cryptocurrency with a fixed exchange rate to the U.S. dollar.