Stablecoins: What They Are, How They Work and Why They Are Freaking Out Crypto Investors

Bitcoin and other cryptocurrencies are extremely volatile, especially compared with conventional financial instruments like stocks and bonds. 

That volatility plays a central role in crypto's appeal for investors. Sure, you can lose all your money on any coin or token -- or you could become a millionaire overnight. 

There is, however, a subset of cryptocurrencies designed to hold steady, to provide a value that doesn't fluctuate. They're called stablecoins, and they're playing an important role in cryptocurrency markets.

At the moment, a number of stablecoins -- specifically terraUSD and tether -- are making headlines for their respective failures to deliver stability. 

Terra has now lost nearly 100% of its value and tether, the largest and most popular stablecoin, is showing signs of fragility. 

Stablecoins have become central to the crypto ecosystem, serving important functions for investors and speculators. 

Below, we'll run through what makes a stablecoin one -- in theory, anyway -- how they're different from other cryptocurrencies and how people are using them today.

A stablecoin is cryptocurrency with a twist. Instead of being "mined'' by an open, distributed network of computers performing a combination of math and recordkeeping, a stablecoin derives its price from the value of another asset. In short, a stablecoin is pegged to another underlying asset.

The most prominent stablecoins are the ones used for trading on crypto exchanges. 

These include tether, the most popular stablecoin, which is usually in the top-five highest market caps for cryptocurrencies; USD coin, or USDC, an open-source project run by a consortium called Centre; and binance USD, a stablecoin issued by Binance, the world's largest crypto exchange. 

The primary use for a stablecoin is facilitating trades on crypto exchanges. Instead of buying bitcoin directly with fiat currency, like the US dollar, traders often exchange fiat for a stablecoin -- and then execute a trade with the stablecoin for another cryptocurrency like bitcoin or ether. 

In this way, stablecoins are sort of like poker chips for crypto exchanges. 

The most widely traded stablecoins are each associated with a specific exchange: tether with Bitfinex; USD coin with Coinbase; binance USD with Binance.

Though advanced crypto traders may use stablecoins for a variety of purposes, including staking and lending, most beginners use them to mitigate trading fees. 

That's because many exchanges don't charge for exchanging US dollars for a stablecoin. Coinbase, for example, doesn't charge any fees on USDC to US dollar transfers. 

If you're looking to quickly liquidate bitcoin at a certain price, you can transfer it into a less volatile entity like USD coin or tether. 

In fact, tether currently accounts for more than half of all bitcoin traded into fiat or stablecoin, according to CryptoCompare, a global cryptocurrency market data provider.

Another use for stablecoins is remittances; that is, transferring funds across international borders. 

Sol Digital, a stablecoin that's pegged to Peru's sol national currency, launched on the Stellar blockchain in September. 

It can be exchanged between individuals in different countries without incurring the considerable fees exacted by third parties for cross-border money transfers.

And it's within this use case that lies the seed of one of bitcoin's more grandiose potential goals -- namely, to give relief to populations that are subject to rapid inflation and could benefit from transferring funds out of a distressed local currency into a stablecoin. 

(As long as the stablecoin isn't tied to that local currency, it would theoretically be insulated from the regional inflation.) 

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