Cryptocurrencies, like Bitcoin (BTC) and Ether (ETH), have gained significant popularity in recent years. However, their inherent volatility poses challenges when it comes to using them as a medium of exchange for everyday transactions. This is where stablecoins come into play, offering stability and reducing price volatility.
Stablecoins employ various mechanisms to maintain their stability. The most common method involves pegging their value to a specific fiat currency, such as the US dollar, or a particular commodity like gold. By pegging their value, stablecoins ensure their price remains closely tied to the underlying asset.
Let’s start with understanding the types of stable coins before we delve deeper into the working of Celo Dollar.
1. Fiat-backed stablecoins:
2. Crypto-backed stablecoins:
3. Commodity-backed stablecoins:
4. Algorithmic stablecoins:
When choosing a blockchain network for launching a stablecoin, the primary consideration should be the desired supply and demand volume for the project. The choice of blockchain will have implications for the stability and flexibility of the stablecoin. There are three main approaches:
Ultimately, the choice of the blockchain network depends on the specific requirements and goals of the stablecoin project, including factors like decentralization, stability, and scalability.
It showcases the process of creating and selling Celo Dollars, which is a stablecoin designed to be pegged to the value of gold. The protocol aims to achieve stability by expanding the supply of Celo Dollars until their market price reaches $1. This expansion is accomplished by creating new Celo Dollars and offering them for sale on the open market. In exchange for these newly created Celo Dollars, individuals can purchase them using Celo Gold and other crypto assets, which are then added to Celo's reserve.
To ensure the stability of the Celo Dollar, a smart contract is employed. This contract maintains a fixed ratio between the supply of Celo Dollars and the value of Celo Gold held in the reserve. By monitoring this ratio, the protocol can adjust the supply of Celo Dollars accordingly, expanding it when the market price is below $1 and contracting it when the price rises above $1.
It illustrates the contraction process employed by the protocol when the market price of Celo Dollars falls below $1. To restore the value of the stablecoin, the protocol uses Celo Gold and other assets from the reserve to purchase Celo Dollars from the open market. Once acquired, these purchased Celo Dollars are "burned," meaning they are permanently removed from circulation and their value is effectively lost.
This contraction mechanism reduces the supply of Celo Dollars in circulation, helping to maintain the Stable coin's value and peg to the targeted $1 price. The protocol monitors the market price of Celo Dollars and initiates the contraction process until the price returns to the desired level.
In conclusion, stable coins play a crucial role in bridging the gap between fiat currencies and cryptocurrencies by offering stability and reducing price volatility. They serve as a reliable medium of exchange and store of value, providing stability comparable to traditional fiat currencies while leveraging the benefits of blockchain technology. At Inovatyv we help ogranisations solve business problems, find industry opportunities using blockchain and AI as the underlying technology. If you’re thinking about building your own stable coins drop us a note here.