TL;DR TL;DR Stablecoins are cryptocurrencies designed to maintain a stable value, often pegged to fiat currency like the US dollar, though true stability hasn't always been achieved. The sources identify five primary types: Fiat-backed (most common, backed by reserves, but less decentralized), Cryptocurrency-backed (backed by other crypto, often overcollateralized), Algorithmic (rely on code and incentives, history of failures like Terra/Luna), Commodity-backed (linked to assets like gold, niche and require verification), and Flatcoins (emerging, aim to preserve purchasing power over time rather than a fixed nominal value, presenting unique collateral and regulatory challenges, with energy-backed designs being explored as an alternative approach). The 5 Types of Stablecoins Stability in crypto is more than a fixed dollar peg. This is a dynamic space, and it has not consistently demonstrated perfect stability, despite the name. However, they are by far of the most globally useful things out there. Most people are familiar with USDT & USDC with their 90%+ market cap dominance, but there is more to stablecoins than that. Fiat-Backed Stablecoins Fiat-Backed Stablecoins These are the dominant players, widely recognized. Examples include USDT and USDC. The underlying principle is straightforward: one cryptocurrency coin is intended to represent one unit of fiat currency, typically the US dollar. They are the most popular type and, in my assessment, have exhibited the highest degree of stability to date, capturing over 90% of the market share. Public trust in these is considerable. However, a key challenge is their reliance on traditional banking infrastructure and government bonds for backing. From my perspective, this counteracts the core principle of decentralization inherent in cryptocurrency. Nevertheless, they provide significant utility, particularly for individuals who face challenges accessing the US dollar through conventional banking channels. While functional, they do not fully embody the decentralized ethos of cryptocurrency. USDT USDC counteracts the core principle of decentralization inherent in cryptocurrency Cryptocurrency-Backed Stablecoins Cryptocurrency-Backed Stablecoins These emerged as a decentralized alternative to fiat-backed variants. The objective remains the same – a peg to the US dollar. One coin represents one US dollar value on-chain. The distinction lies in the reserve assets; instead of relying on bank reserves or treasury bonds, they utilize other cryptocurrencies such as ETH or BTC. The most notable example is DAI from MakerDAO. DAI operates on an overcollateralization model. This necessitates depositing significantly more collateral  (~150% or more in other cryptocurrencies) to mint $1 worth of DAI. Requiring 150% collateral for a stablecoin representing merely $1 lacks capital efficiency while still being risky. See Black Thursday: The sell-off of 12 March resulted in $4.5 million of unbacked DAI in the MakerDAO system. DAI from MakerDAO lacks capital efficiency Black Thursday: The sell-off of 12 March resulted in $4.5 million of unbacked DAI in the MakerDAO system Algorithmic Stablecoins Algorithmic Stablecoins This category involves more complex designs, and their history has been challenging. These systems aim to minimize reliance on substantial collateral, depending instead on code, algorithms, and market incentives to maintain their peg. They frequently employ a two-token system where one token is designed for stability, while a correlated, volatile token absorbs price fluctuations. Smart contracts manage these processes, adjusting supply through minting or burning to facilitate arbitrage and price stability. code, algorithms, and market incentives While theoretically compelling, practical implementation has faced significant difficulties. The notable collapse of the Terra/Luna USD system in 2022 serves as a primary illustration. This event resulted in a collapse ("death spiral"), the peg was entirely lost, and substantial financial losses occurred. This incident has cast a significant shadow upon algorithmic stablecoins. Presently, they exhibit low adoption, and it remains to be seen if a viable new design will emerge. Terra/Luna USD cast a significant shadow upon algorithmic stablecoins they exhibit low adoption Commodity-Backed/Tied Stablecoins Commodity-Backed/Tied Stablecoins The concept here is to link value to a commodity such as gold. Attempts involve either an algorithmic peg to the commodity price or claims of holding the physical commodity in reserve. Frankly, this segment is highly specialized. The algorithmic variants face similar trust challenges as algorithmic stables. For those claiming physical reserves, verification is critical. Rigorous audits would be necessary to establish personal trust in such claims. A mere assertion of gold reserves in a vault is insufficient. (I am personally curious to see where this goes with gold as this really seems to be a market with high interest.) gold highly specialized similar trust challenges as algorithmic stables Rigorous audits would be necessary to establish personal trust Flatcoins Flatcoins This represents a relatively nascent narrative that is gaining attention. Instead of targeting a fixed dollar value (nominal value), flatcoins aim to preserve their real value or purchasing power over time. Various approaches are being explored: relatively nascent narrative preserve their real value or purchasing power over time real Some peg to the US inflation index, utilizing oracles to track inflation data and adjust the coin's value. For instance, a coin purchased for $1 might be designed to be worth $1.05 a year later if inflation registered 5%. Nuon V1 attempted this using an oracle and collateral-backed smart contracts. However, the current status and trajectory of the Nuon project appear unclear, with low market capitalization (approximately 100K) and limited activity following the V2 launch. My understanding of this project's current direction is genuinely limited.
Other models, like Ampleforth (AMPL), adjust the quantity of tokens held rather than the price, aiming for a historical USD purchasing power target. Ampleforth possesses a larger market capitalization, noted around 30 million at my last check. Some peg to the US inflation index, utilizing oracles to track inflation data and adjust the coin's value. For instance, a coin purchased for $1 might be designed to be worth $1.05 a year later if inflation registered 5%. Nuon V1 attempted this using an oracle and collateral-backed smart contracts. However, the current status and trajectory of the Nuon project appear unclear, with low market capitalization (approximately 100K) and limited activity following the V2 launch. My understanding of this project's current direction is genuinely limited. US inflation index Nuon V1 Other models, like Ampleforth (AMPL), adjust the quantity of tokens held rather than the price, aiming for a historical USD purchasing power target. Ampleforth possesses a larger market capitalization, noted around 30 million at my last check. Ampleforth (AMPL) quantity My principal concern with these designs relates to collateral management. How is the required collateral level maintained as the purchasing power target increases over time? If an initial deposit of $1 is made today, but that value must represent $1.05 in the future, could this lead to undercollateralization unless users contribute additional collateral? I believe these designs encounter numerous hurdles analogous to those faced by algorithmic stablecoins. Without genuinely more robust or innovative mechanisms, I remain unconvinced regarding their long-term viability. Furthermore, the regulatory classification of these instruments is also less defined. Their classification, whether as derivatives or indices, remains ambiguous because they are not merely stable; their value is intended to rise, which introduces a speculative element. With low volume, they possess the potential to behave more like speculative altcoins than stable assets. While I appreciate the underlying concept of maintaining purchasing power, I do not believe simply using an inflation oracle and an algorithmic model is sufficient. numerous hurdles analogous to those faced by algorithmic stablecoins more robust or innovative mechanisms behave more like speculative altcoins Energy Money as Digital Cash? But what if you do not rely on the US dollar at all? What if its value was linked to an asset that possesses intrinsic stability potentially exceeding that of the US dollar? Energy could serve as such an asset. you do not rely on the US dollar at all possesses intrinsic stability potentially exceeding that of the US dollar Energy This concept leverages the Proof-of-Work infrastructure. By analyzing global mining costs, primarily electricity prices (as hardware costs have become less significant), one can estimate the cost of producing the coin. The aim is to tie the coin's value to these production costs. This is conceptually similar but not the same as the historical gold standard, where value was linked to a resource. A key distinction is the one-way backing. Energy contributes to the creation of coins (via mining cost), but coins are not exchanged back for physical energy. This model is rational given that the cost of energy is fundamental to the production of almost everything. Proof-of-Work infrastructure one-way backing cost of energy is fundamental to the production of almost everything The potential for a crypto-native asset that does not rely on central bank infrastructure for its value is, in my opinion, exceptionally valuable. Bitcoin is effective for storing value, but its volatility limits its utility for everyday transactions; it is typically hodled rather than spent. Therefore, there is a need for an asset with greater value stability than Bitcoin and that possesses a propensity for spending. crypto-native asset that does not rely on central bank infrastructure for its value exceptionally valuable greater value stability than Bitcoin The Evolving Landscape Currently, fiat-backed stablecoins like USDT and USDC dominate the market due to user comfort and their reliable peg to the US dollar. However, the other types represent ongoing innovation in the pursuit of different forms of stability. Current USDT alternatives face hurdles, but it is exciting to see innovative approaches like the energy concept offer potential pathways toward creating truly crypto-native assets. As it stands now, the stablecoin focus will continue to grow and evolve, especially as they are accepted for day-to-day payments in more places. If you prefer an MP4 format, here is a video I made on the topic: If you prefer an MP4 format, here is a video I made on the topic: https://youtu.be/Z_Clqd91fHQ?embedable=true https://youtu.be/Z_Clqd91fHQ?embedable=true Key Terms Glossary Key Terms Glossary When preparing this article, I have referenced multiple terms that might be not widely familiar to you if you are not that deep into crypto. So, here is an FAQ-style glossary for those (yes, AI helped me with that): Algorithmic Stablecoin: A stablecoin that uses code and algorithms, often with a dual-token model and market incentives, to maintain its value without significant collateral reserves.
Arbitrage: The simultaneous buying and selling of an asset in different markets to profit from slight price differences. In the context of stablecoins, arbitrageurs help maintain the peg by buying undervalued coins and selling overvalued ones.
Collateral: An asset or group of assets held as security for a loan or, in the case of stablecoins, to back the value of the issued tokens.
Commodity-Backed Stablecoin: A stablecoin whose value is pegged to and/or backed by the value of a specific commodity, such as gold.
Cryptocurrency-Backed Stablecoin: A stablecoin whose value is backed by a reserve of other cryptocurrencies, often in an over-collateralized manner.
Decentralization: The principle of distributing power and control away from a central authority, a core tenet of many cryptocurrencies.
Dual Token Model: A system used by some algorithmic stablecoins where one token is designed to be stable and another, often a volatile "governance" or "utility" token, absorbs the volatility and helps maintain the peg.
Energy-Backed Stablecoin: A conceptual stablecoin whose value is tied to the cost of producing it, primarily based on the cost of energy (like electricity for mining).
Fiat Currency: Government-issued currency that is not backed by a physical commodity like gold or silver, such as the US Dollar or Euro.
Fiat-Backed Stablecoin: A stablecoin whose value is pegged to and backed by a reserve of fiat currency held in a traditional financial institution.
Flatcoin: A type of stablecoin that aims to maintain its real value or purchasing power over time, rather than being pegged to a fixed nominal value like $1. This can be attempted by tying its value to inflation indices or other mechanisms.
Inflation Index: A measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services, used to track inflation.
Market Capitalization (Market Cap): The total market value of a cryptocurrency or company's outstanding shares, calculated by multiplying the current price per token/share by the total number of tokens/shares in circulation.
Oracle: A service that provides real-world data (like inflation rates or commodity prices) to smart contracts on a blockchain.
Over-collateralization: The practice of holding more collateral than the value of the stablecoin being issued (e.g., $1.50 in ETH for every $1 of stablecoin).
Peg: The target value that a stablecoin aims to maintain, typically tied to a fiat currency like the US Dollar (a $1 peg).
Proof of Work (PoW): A consensus mechanism used in some cryptocurrencies (like Bitcoin) where participants (miners) use energy-intensive compute power to validate transactions and add new blocks to the blockchain.
Purchasing Power: The value of a currency or asset in terms of the goods and services that can be bought with it. Maintaining purchasing power means being able to buy the same amount of goods and services over time, despite inflation.
Reserves: The assets (fiat, cryptocurrency, commodities, etc.) held by a stablecoin issuer to back the value of the stablecoin in circulation.
Smart Contract: A self-executing contract with the terms of the agreement directly written into lines of code. They automatically execute actions when specific conditions are met.
Stablecoin: A type of cryptocurrency designed to minimize price volatility, typically by being pegged to an asset or basket of assets.
USDC (USD Coin): A popular fiat-backed stablecoin pegged to the US Dollar.
USDT (Tether): The largest and one of the most popular fiat-backed stablecoins, also pegged to the US Dollar.
Volatility: The tendency of an asset's price to fluctuate significantly and rapidly. Stablecoins aim to have low volatility. Algorithmic Stablecoin: A stablecoin that uses code and algorithms, often with a dual-token model and market incentives, to maintain its value without significant collateral reserves. Algorithmic Stablecoin: Arbitrage: The simultaneous buying and selling of an asset in different markets to profit from slight price differences. In the context of stablecoins, arbitrageurs help maintain the peg by buying undervalued coins and selling overvalued ones. Arbitrage: Collateral: An asset or group of assets held as security for a loan or, in the case of stablecoins, to back the value of the issued tokens. Collateral: Commodity-Backed Stablecoin: A stablecoin whose value is pegged to and/or backed by the value of a specific commodity, such as gold. Commodity-Backed Stablecoin: Cryptocurrency-Backed Stablecoin: A stablecoin whose value is backed by a reserve of other cryptocurrencies, often in an over-collateralized manner. Cryptocurrency-Backed Stablecoin: Decentralization: The principle of distributing power and control away from a central authority, a core tenet of many cryptocurrencies. Decentralization: Dual Token Model: A system used by some algorithmic stablecoins where one token is designed to be stable and another, often a volatile "governance" or "utility" token, absorbs the volatility and helps maintain the peg. Dual Token Model: Energy-Backed Stablecoin: A conceptual stablecoin whose value is tied to the cost of producing it, primarily based on the cost of energy (like electricity for mining). Energy-Backed Stablecoin: Fiat Currency: Government-issued currency that is not backed by a physical commodity like gold or silver, such as the US Dollar or Euro. Fiat Currency: Fiat-Backed Stablecoin: A stablecoin whose value is pegged to and backed by a reserve of fiat currency held in a traditional financial institution. Fiat-Backed Stablecoin: Flatcoin: A type of stablecoin that aims to maintain its real value or purchasing power over time, rather than being pegged to a fixed nominal value like $1. This can be attempted by tying its value to inflation indices or other mechanisms. Flatcoin: Inflation Index: A measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services, used to track inflation. Inflation Index: Market Capitalization (Market Cap): The total market value of a cryptocurrency or company's outstanding shares, calculated by multiplying the current price per token/share by the total number of tokens/shares in circulation. Market Capitalization (Market Cap): Oracle: A service that provides real-world data (like inflation rates or commodity prices) to smart contracts on a blockchain. Oracle: Over-collateralization: The practice of holding more collateral than the value of the stablecoin being issued (e.g., $1.50 in ETH for every $1 of stablecoin). Over-collateralization: Peg: The target value that a stablecoin aims to maintain, typically tied to a fiat currency like the US Dollar (a $1 peg). Peg: Proof of Work (PoW): A consensus mechanism used in some cryptocurrencies (like Bitcoin) where participants (miners) use energy-intensive compute power to validate transactions and add new blocks to the blockchain. Proof of Work (PoW): Purchasing Power: The value of a currency or asset in terms of the goods and services that can be bought with it. Maintaining purchasing power means being able to buy the same amount of goods and services over time, despite inflation. Purchasing Power: Reserves: The assets (fiat, cryptocurrency, commodities, etc.) held by a stablecoin issuer to back the value of the stablecoin in circulation. Reserves: Smart Contract: A self-executing contract with the terms of the agreement directly written into lines of code. They automatically execute actions when specific conditions are met. Smart Contract: Stablecoin: A type of cryptocurrency designed to minimize price volatility, typically by being pegged to an asset or basket of assets. Stablecoin: USDC (USD Coin): A popular fiat-backed stablecoin pegged to the US Dollar. USDC (USD Coin): USDT (Tether): The largest and one of the most popular fiat-backed stablecoins, also pegged to the US Dollar. USDT (Tether): Volatility: The tendency of an asset's price to fluctuate significantly and rapidly. Stablecoins aim to have low volatility. Volatility: Featured Image source: https://www.finextra.com/newsarticle/46055/the-fca-bundles-stablecoins-into-new-crypto-regime Featured Image source: https://www.finextra.com/newsarticle/46055/the-fca-bundles-stablecoins-into-new-crypto-regime https://www.finextra.com/newsarticle/46055/the-fca-bundles-stablecoins-into-new-crypto-regime

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