Stablecoins are a type of cryptocurrency whose value is pegged to some external reference value like the U.S. Dollar.

A peg typically requires that a managing entity holds a reserve of the currency to which is being pegged. Historically, when a currency like the Thai Bhat is pegged to the U.S. Dollar, the central bank of Thailand would have a reserve of U.S. dollars that it could sell if necessary to maintain the peg. When the U.S. Dollar was pegged to gold prior to 1971, the Federal Reserve held a reserve of gold for maintaining this peg.

Similarly a stablecoin requires a reserve of the pegged currency. It is important that this reserve be present and transparent, otherwise the managing entity may not be able to maintain the peg.

Stablecoins are a form of managed cryptocurrency and they are typically managed by a consortium. The largest stablecoins run on the Ethereum blockchain.

Tether (USDT) is the largest stablecoin by market capitalization (over $50 billion). Tether is an Ethereum token that is pegged to the value of the U.S. Dollar. Tether has had some legal issues in the past due to concerns about their dollar reserves. The issuer of Tether claims that USDT is backed by bank reserves and loans which match or exceed the value of USDT in circulation.

USD Coin (USDC) is another example of a stablecoin. USDC dollar reserves are regularly audited by the auditing firm Grant Thornton, LLP. USDC is managed by consortium called Centre, which was founded by Circle and includes Coinbase and Bitmain. USDC was launched in September 2018. On March 29, 2021, Visa announced that it would allow the use of USDC to settle transactions on the Visa network.

Dai (or DAI) is another stablecoin that runs on Ethereum and is pegged 1:1 to USD. It maintains its value through an automated system of smart contracts on Ethereum. Dai is managed by MakerDAO, a decentralized autonomous organization (DAO).

Facebook attempted to launch a stablecoin called Libra, but the U.S. company ran into stiff regulatory opposition among federal lawmakers.

Stablecoins are an interesting form of cryptocurrency, because they “solve” the volatility problem in cryptocurrencies like Bitcoin. Many people like to say that cryptocurrency will never function as money because its value is too volatile. Stablecoins eliminate all volatility of a cryptocurrency relative to an underlying asset. For instance, a stablecoin pegged to the US dollar is designed to trade 1:1 with the dollar. This means that stablecoins could potentially be the future of a digital payments system. They have the benefits of cryptocurrency without the volatility.

Stablecoins are also “back to the future” in the sense of pegged international currencies. Under the Bretton Woods Agreement after WWII, international currencies were pegged to one another in a system of fixed exchange rates. Currencies were pegged to the US dollar and the US dollar was pegged to the value of gold. The goal of Bretton Woods was to stabilize exchange rates and facilitate increased international trade. Stablecoins function in a similar manner of stabilizing exchange rates between fiat currency and cryptocurrency. In doing so, stablecoins may facilitate more trade across these two monetary systems.

Here is an informative article by Akash Takyar, CEO of LeewayHertz, about How to Create a Stablecoin. The illustrations are particularly helpful.