In the crypto world, stablecoins are about the only asset that has something of a predictable trajectory. But stablecoins don't just come in one form. Different stablecoins have their own dynamics, benefits, and drawbacks depending on what category they fall into. So, let's discuss the four main types of cryptocurrency stablecoin.

1/ Stable coins backed by fiat currency

Fiat currency is not backed by a physical commodity, such as a precious metal (at least for now). Fiat money is issued by the government, just like non-fiat money (backed by a commodity), but it still depends on the balance of supply and demand to maintain its value. For example, the US dollar is a fiat currency (although it used to be a non-fiat currency when it was backed by gold).

Thus, fiat steiblocoins are tied to any asset that is not itself backed by a physical commodity. Most fiat stablcoins are backed at a 1:1 ratio. For example, USD Coin (USDC) is a stable coin that is pegged to the US dollar at a 1:1 ratio, meaning that one USDC is equivalent to one dollar. Thus, for every USDC issued, there is one US dollar held in reserve.

Although fiat-backed cryptocurrencies are more stable than conventional cryptocurrencies, they are centralised. This allows them to maintain a 1:1 ratio with their collateral. This means that central authorities control USD Coin, which requires users to trust strangers when investing in fiat stable coins.

2/ Stable coins backed by cryptocurrencies

As the name suggests, cryptocurrency stablecoins are backed by cryptocurrencies. This may seem a bit oxymoronic, as traditional cryptocurrencies are so volatile that it is often impossible to peg a Stablecoin to one of them at a 1:1 ratio. Well, cryptocurrency stablecoins don't work quite the same way as fiat stablecoins, as they don't use a 1:1 peg.

Instead, cryptocurrency-backed stablecoins often have excess collateral to compensate for the very high probability that the collateral used will experience a change in price. This is often referred to as "collateral".

Take Dai (DAI), for example. This Stablecoin can be borrowed on the MakerDAO lending platform, provided that the borrower deposits cryptocurrency collateral. At the moment, users can use Ethereum (ETH), Basic Attention Token (BAT), Compound Token (COMP) and USD Coin (USDC). Anyone who wants to borrow DAI must post more collateral than they are borrowing. And if their collateral loses too much value while it is on deposit, they may have to liquidate it and return the borrowed DAIs.

Wrapped Bitcoin (WBTC) is another example of a stable cryptocurrency-backed coin. Although this coin exists on the Ethereum blockchain, it is backed by bitcoin. In fact, the Wrapped Bitcoin project currently holds more than 280,000 BTC as a reserve for WBTC, with Ethereum used as collateral.

3/ Stable coins backed by commodities

Stablecoins backed by commodities are backed by physical commodities such as gold, silver or oil. Even real estate can be used as collateral for this type of stackablecoin. In a sense, commodity-backed stablecoins are a digital representation of a valuable real asset. But why would anyone want it?

Commodity-backed stablecoins are particularly useful for those who find it difficult to get their hands on literal precious materials but still want to invest in them. By investing in, say, a commodity-backed stabelcoin backed by gold, the investor gets something that has the same value as the collateral and can be liquidated if desired. And because the value of these assets is not as volatile as fiat or cryptocurrencies, investing in commodity-backed stablecoins can be a safer route.

Gold tends to be the most popular collateral for stable commodity-backed coins. Take Paxos Gold (PAXG), for example. The value of one PAXG is pegged 1:1 to the value of one troy ounce of London good supply gold bullion. At the time of writing, that value is around $1,800, although the price fluctuates daily.

Tether Gold (XAUt) is another example of a stable gold-backed coin. As with Paxos Gold, one XAUt token is pegged 1:1 to the value of one troy ounce of gold in Good Delivery bullion in London, so its value is also currently around US$1,800.

4/ Algorithmic Stablecoins

Unlike the other types of stable coins discussed here, algorithmic stable coins are not backed by other assets. Their value is backed by computer algorithms. Although an algorithmic stablecoin can be tied to another asset (i.e., its price is correlated with it), it does not have any collateral. The algorithms used by this type of stablecoin typically control the availability of the coin, which in turn can control its value.

You may have seen the term "algorithmic stablecoin" in the news in May and June 2022 during the collapse of Terra's two cryptocurrencies, Luna and TerraUSD. The latter of these two coins, TerraUSD, was an algorithmic stablecoin pegged to (but not backed by) the US dollar, which maintained its value through a relationship with Luna (LUNA).

If the price of Terra exceeded one US dollar, part of it was burned, and if the price fell below a dollar, part of LUNA was burned. However, a series of events led to investors dumping their USTs, causing a huge surge in supply. And, as is often the case in the crypto industry, the price of the coin is likely to plummet if demand is low and supply is high. This also caused a huge collapse in the price of LUNA.

The UST/LUNA crash was a lesson in why algorithmic stackcoins are risky. Without legal collateral, the likelihood of price destabilisation is much higher. However, algorithmic stablcoins do not require centralisation and do not need to be controlled by a central authority, suggesting a decentralised structure that is respected and trusted by crypto-enthusiasts.

Stablecoins have an exciting future in the crypto industry Unlike most other cryptocurrencies, stablecoins offer investors a much higher level of reliability in terms of value. While stablecoins can and have crashed, the probability of such an event happening for them is much lower than for traditional cryptocurrencies. So if the volatility of the cryptocurrency market scares you away, check out some of the big stable coins to see if they might be right for you.