Stablecoins are cryptocurrencies whose value is pegged to "stable" assets such as fiat currencies or commodities. For example, the price of a USD-pegged stablecoin should theoretically always be $1. Stablecoins are designed as an alternative to most cryptocurrencies, which have highly volatile prices. There are four main types of stablecoins based on the classification of the underlying assets being mortgaged.
The most popular stablecoins are fiat stablecoins that correspond 1:1 to real-world fiat currencies. Fiat currency is pledged to issuers in exchange for stablecoins. The corresponding legal currency is usually the US dollar, including $USDT, $USDC, $BUSD, etc. Stablecoins pegged to the euro ($EUROC) or other fiat currencies are also being issued.
Cryptocurrency stablecoins are also typically equivalent to the U.S. dollar, but backed by another cryptocurrency. Such stablecoins typically require over-collateralization to compensate for the risk of price fluctuations in the collateralized assets. For example, the collateral for $DAI is $ETH deposited in the MakerDAO vault.
Commodity stablecoins are collateralized by physical assets such as precious metals. For example, one Pax Gold ($PAXG) token corresponds to one troy ounce gold bar.
Algorithmic stablecoins rely on algorithms and smart contracts to keep their prices the same as fiat currencies. If the price of an algorithmic stablecoin falls below the price of the fiat currency it is pegged to, its circulating supply will be reduced to increase the price and restore the peg. For example, the price of USD-pegged $FRAX is partially backed by collateral and partially algorithmically stabilized. $USTC (formerly $UST) is a “famously” failed algorithmic stablecoin project that decoupled from the U.S. dollar in May 2022 and has yet to recover.