In my previous article we talked about stable coins, what they are, their importance, and what they are for within the blockchain platform, if you missed it click here so you can understand what we are talking about. In a summary, we could tell you that stable coins allow us to have crypto assets that allow us to have value reserves without the risks of cryptocurrency market volatility.
Now is the time to understand how it is possible for a currency, despite the movements and ups and downs of cryptographic supply and demand, to be able to keep its value stable, what type of stable coins exist, and what are the mechanisms that operate to stabilize said value.
How does the value of a cryptocurrency stay stable?
A stablecoin is capable of regulating its value and keeping it immutable through different mechanisms, these can be using fiat currencies, precious metals, securities, smart contracts, and even other cryptocurrencies that serve as support and value reference. In this way, despite the variation in demand, the stable coins maintain their reference value based on the other value that supports it or the software that regulates it. Let's look at some of the existing mechanisms.
Stable coins that are backed by fiat currencies (Fiat-Backed)
Given the fact that most investors still maintain greater confidence and feel more secure protecting their capital in currencies issued by national central banks, one of the mechanisms most used by the creators of stablecoins is to use currencies such as the dollar, the euro, the British pound or the Japanese yen that serves as a guarantee for their tokens.
When this type of mechanism is used, a 1:1 exchange parity is generally maintained, that is, for each token issued there must be a fiat currency that supports it, in other words, a digital monetary unit corresponds to a traditional monetary unit. Fiduciary currencies are kept safe in traditional banks or other financial institutions that certify the existence of said values.
The two main disadvantages of this backup method are how much trust it can generate based on the amount of fiat money available, as well as where it is stored. The other disadvantages have to do with the ability to scale the project, I will try to explain the above a little better through an example:
Suppose I want to create a new project called Karupanocitizenrich which has its altcoins the "Karupa Dollar" (KPD) and I want it to maintain a 1: 1 parity concerning the US dollar, which is the currency that will serve as support. If I want to issue 2,000,000 KPD's, I must have the same number of US dollars, not only that, but they must be in deposit in a trustworthy bank such as Barclays or HSBC, because no one will believe me if I say that I have them under the protection of the Karupano Bank of America, for example.
A final limitation of this type of "Fiat-Backed" projects is that in some way they are subject to or under the influence of the decisions made by the government entities that issue the coins that serve as sustenance, so "philosophically" speaking the token and the project lose part of their decentralized character.
Commodity Backed or tokens backed with raw materials or precious materials
Within this group of altcoins, we have those whose value reserve is guaranteed by the existence of some type of raw material, material good, or what is known in financial jargon as commodities. The tangible goods most used to support this type of project are precious metals such as gold and silver, which are widely interchangeable and are widely accepted in the market.
The mechanism to guarantee the value of each token is simple: an equivalent proportion of the precious metal is granted to the stable coin issued, that is, 1 gram is equivalent to 1 token, for example, a Digix Gold is equal to one gram of gold. In this way, it is possible to provide the crypto asset with a balance in its price. For this to be accepted as true, the gold must be kept in bullion as a reserve, being able to be certified and audited by a reliable third party that provides users with the certainty of their support.
Another example of this type of very controversial crypto asset, by the way, is the crypto asset: Petro. This alcohol is a currency backed by Venezuela's oil reserves, created especially to provide "economic stability" in the face of the harsh political and social situation that the Caribbean nation is going through. However, many critics believe that said currency is nothing more than a scam of the Venezuelan government and does not constitute in any way a cryptocurrency.
I'm sure this topic is quite interesting and I'm enjoying our conversation, but it's time to read your opinion about it, what do you think of the two stable coins guarantee mechanisms that we learned? Do you consider that this type of crypto activity corresponds to the current development of the different blockchain projects? What is your opinion about the Venezuelan crypto active? In the next article I will be developing the rest of the mechanisms used as a guarantee of the stable coins, meanwhile ... I hope to read them in the comment box.
We keep reading!