A stablecoin is a cryptocurrency linked to the value of fiat currencies such as the Euro.
The difference with a "regular" cryptocurrency is that the price is not determined by the open market but by a "fiat" currency such as the Euro or the U.S. dollar. A stablecoin offers the benefits of a stable currency with the advantages of a cryptocurrency. For example, stablecoins are faster to transmit internationally than transactions through a bank.
A stablecoin has a number of advantages over bitcoin, for example. The volatility of bitcoin makes it difficult to use as a means of payment. The moment a transaction is sent, it can already be worth less. Many entrepreneurs and companies are therefore not yet waiting to fully switch to crypto as a means of payment. A stable coin offers a solution for this; it is equal in value to the U.S. dollar, for example.
For trading at brokers and exchanges, it can be useful to hold stablecoins to buy other coins, as stablecoins are less volatile than other coins.
There are three different types of stablecoins:
Fiat-backed stablecoins are linked to a fiat currency such as the dollar or the euro.
The organization behind USD Coin, Circle buys back a dollar for every coin sold, which they store in a normal bank account. So this way you do have the value of the dollar without having to put it in a normal bank account.
Dai is an example of a crypto-backed stablecoin, meaning that the coin is backed by another cryptocurrency.
For every 100 Dai issued, 150 Ethereum are collateralized. In this way, the value can be guaranteed.
The disadvantage of a crypto-backed coin is that it is tied to the value of another cryptocurrency.
In case it is worth nothing, this could also cause stablecoin to be worth nothing. Stability also depends on price fluctuations of Ethereum.
The way algorithm-backed stablecoins are regulated is somewhat similar to how the ECB regulates the Euro. When the price of a stablecoin becomes too high, the algorithm will automatically create new coins and put them into circulation. Conversely, the algorithm will buy coins from the market when the price is too low.
Making the number shrink, however, is a lot trickier than refilling the coins. Of course, the coins must be offered for sale before they can be repurchased. When prices are low, the supply is often low as well.
It is therefore important that developers write an algorithm where the price remains constant.
