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Chainlink Educational Blog: What Are Stablecoins?

While cryptocurrencies are often known for their volatility, stablecoins bring newfound stability to cryptocurrency markets by allowing fiat currencies like the U.S. dollar or other stable assets to be represented on the blockchain as digital tokens. These stablecoins allow anyone around the world to hold a synthetic form of fiat currency that’s purposely designed to hold its value in relation to the fiat currency it claims to represent; e.g. 1 USD stablecoin tries to maintain a value of 1 U.S. dollar. The desire for stable assets on the blockchain has resulted in the total value of all stablecoins reaching over $30B in value, as well as the wide adoption of stablecoins within Decentralized Finance (DeFi) applications.

In this article, we’ll walk through the fundamental questions around stablecoins, such as what they are, how they work, and how Chainlink oracles are enabling their development and security, ultimately allowing stablecoins and DeFi markets to reach their full potential.

What Are Stablecoins?

At their core, stablecoins are cryptocurrencies that try to maintain a “peg”, wherein the stablecoin aims to maintain the same market value as the external asset they represent. To achieve price stability of the peg, stablecoins can be backed by external assets (collateralized) or make use of algorithms that dynamically adjust their supply in relation to their demand at a given time (algorithmic).

There are two main types of stablecoins that exist: centralized and decentralized. Centralized stablecoins are traditionally backed by fiat currency in an off-chain bank account that functions as the reserves backing the tokens on-chain. These typically require a layer of trust in the custodian, although they are increasingly providing more transparency through solutions like Chainlink Proof of Reserve (discussed more below). Alternatively, decentralized stablecoins are commonly overcollateralized by on-chain cryptocurrenci...

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