What is stablecoin?

A stablecoin is a type of cryptocurrency designed to maintain a stable value by pegging its price to a reserve of assets or by using algorithmic mechanisms. The goal of stablecoins is to reduce the price volatility commonly associated with other cryptocurrencies like Bitcoin and Ethereum, making them more suitable for everyday transactions and as a store of value.
There are different types of stablecoins, and they can be categorized into three main groups:

1. Fiat-Collateralized Stablecoins: These stablecoins are backed by a reserve of fiat currency, such as the US dollar or the euro, held in a bank account. For every unit of the stablecoin in circulation, there is an equivalent amount of fiat currency in the reserve. Tether (USDT) and USD Coin (USDC) are examples of fiat-collateralized stablecoins.
2. Crypto-Collateralized Stablecoins: These stablecoins are backed by a reserve of other cryptocurrencies. The value is maintained through over-collateralization, meaning that the value of the reserve is higher than the value of the circulating stablecoins. Examples include DAI, which is pegged to the US dollar and backed by a basket of cryptocurrencies on the Ethereum blockchain.
3. Algorithmic or Non-Collateralized Stablecoins: These stablecoins use algorithms and smart contracts to control the supply of the stablecoin in order to maintain a stable value. The algorithmic approach involves mechanisms like adjusting the supply based on demand or using external price feeds. Terra (LUNA) and Ampleforth (AMPL) are examples of algorithmic stablecoins.

Stablecoins have gained popularity because they offer the benefits of cryptocurrencies, such as fast and borderless transactions, while minimizing the price volatility that can be a barrier to widespread adoption and everyday use. They are often used as a bridge between traditional fiat currencies and the world of decentralized finance (DeFi).