The world’s simplest explanation of Stablecoins

Welcome to Intro to Crypto; my 20-part series explaining blockchain and crypto in simple, granny-friendly English.

It's ironic. I'm writing about stablecoins in the same week that most cryptocurrencies have been anything but stable. Some sort of cosmic coincidence? After all, this is the LAST of my 20-part series. It's been a trip. I've gained followers, friends and damned near loved ones the last 20 weeks.

So before we go any further, I want to say a huge thank you to everybody who's read any part of my (not so mini) mini series Intro to Crypto. I do it all in the hope that it'll prove useful to the future crypto curious (and that I might accidentally get crypto famous).

Now without further ado, let's get this over with (P.S. this doesn't count towards the 3mins).

Is your currency pegged?

When it comes to currency, the word 'price' can be misleading. Unlike in a store where the owner sets the price for an armchair or a can of deodorant, a currency has no set 'price'. The price you see is just the last price someone paid for it.

That means it can go up or down depending on what the next person's willing to pay for it. And their willingness to pay more for it usually depends on how much they think it'll be worth to the next person.

But. There's an exception.

This exception is 'pegged' currencies. These are currencies that are always worth the same amount because their price is fixed to the U.S. dollar.

For example, the national currency of Barbados is pegged to the U.S. dollar. This means at any time, night or day, rain or shine, you can exchange 2 Barbados dollars for 1 U.S. dollar. How? Because some people who work for the Barbados government wrote it down on a piece of paper one day and since then everyone's been OK with it.

The same goes for the Hong Kong dollar. According to my friend, Wikipedia, since 1972, 5.65 Hong Kong dollars have always gotten you 1 U.S. dollar.

The same goes for the national currencies of Vietnam, Saudi Arabia, Qatar, Bahamas and a bunch of others–all with their different (but fixed) rates. Once your government writes the rule on a headed paper, you can rest assured that it will always be worth the same number of dollars; no more, no less.

This is exactly how Stablecoins work in the world of cryptocurrencies.

Like most currencies, the price of a cryptocurrency is just the last price someone paid for it. And yes, that includes Dogecoin.

Again, like currencies, the price can go up or down depending on what people are willing to pay for it. And their willingness to pay more for it usually depends on how much they think it'll be worth in the next 10 seconds.

But. There's an exception: stablecoins. These cryptocurrencies are always worth the same amount because they're also fixed to the U.S. dollar.

That means that at any time, whether bitcoin's price is tanking or 'mewning', you can always exchange one stablecoin for one U.S. dollar. How? The same kind of rules that are enforced by the Barbados government are written into the code of the stablecoin to make sure it matches the price of the U.S. dollar.

And it's the same for most stablecoins, including TUSD, USDT, USDC and DAI–all at the same rate of 1 coin for 1 U.S. dollar. Once you buy a stablecoin, you can rest assured that it will always be worth 1 dollar; no more, no less.

This has obvious advantages over cryptocurrencies with more 'volatile' prices. For example, if you sell a car for 1 bitcoin, you can (currently) exchange that bitcoin for $5,000. But if the price of bitcoin falls to $2,500, you'll get half the number of dollars for the same 1 bitcoin.

A stablecoin comes with the benefits of bitcoin (borderless, permissionless, uncensorable etc.) but without the "volatility risk". This gives them all the advantages of an unstoppable cryptocurrency… along with the benefits of a stable and established currency like the U.S. dollar.

Types of Stablecoin

Now don't go thinking all stablecoins are the same. They're different. While many of the world's currencies are pegged to the U.S. dollar and the dollar is pegged to… well, nothing… stablecoins are typically backed by 1 of 3 things.

Currency-backed stablecoins: For every 1 dollar you deposit with the creators of the stablecoin, they give you a single stablecoin worth $1 in return. In this way it's a lot like a bank. USDT is a well-known example of a currency-backed stablecoin.
Crypto-backed stablecoins: The same as the above but using other cryptocurrencies. As cryptocurrencies start to prove themselves, people trust that they can hold their value. DAI is one of these and each DAI stablecoin is backed by a certain amount of ether.
Algorithmic stablecoins: These aren't backed by anything except trust (sound familiar?) and mathematics. When high demand pushes the price up, the network "inflates the supply" (makes new coins) to bring it back down. When high supply pushes the price down the network destroys coins to increase demand. Basis is an example of an algorithmic stablecoin.

Wanna know more? I recommend this article on stablecoins.

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