Fiat-collateralized stablecoin is the most basic and simple form of this cryptocurrency. A central entity (or custodian) puts up an amount of fiat currency as collateral, and stablecoin is issued against the fiat currency at a 1:1 ratio. This form of stablecoin should, in theory, require a periodic audit to ensure that it is truly collateralized.

Right now, the most popular example of fiat-collateralized stablecoin is Tether, which is also the second most-traded cryptocurrency after Bitcoin. Tether is centralized, which implies that its custodian, Tether Limited, possesses the underlying assets represented by each issued stablecoin. But controversy also follows Tether, as it’s unclear whether it truly is US-dollar-backed with fiat reserves.

Another example of this form of stablecoin is Everex’s eFiat, an Ethereum-based token which is pegged to (and backed by) any fiat currency. eFiat (eUSD, eEUR, etc.) can be sent almost instantly anywhere in the world and confirmed by participants on the Ethereum blockchain.

eFiat differentiates itself from Tether in two ways: first, eFiat can be used in daily life to pay bills, transfer money across borders and for purchasing goods and services, while Tether has no value outside of cryptocurrency exchanges. Second, eFiat’s value is 1:1 against its corresponding fiat currency.

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To explain the eFiat mechanism in a simple way, the issuing entity receives the US dollar into a segregated account and issues stablecoins with a 1:1 ratio against the dollar. The conversion rate is 1 USD equals 1 eUSD, which can be used to pay salaries or goods and services. This means that all collaterals are held in real fiat-currencies and resists extreme level of volatility that is faced by the current cryptocurrency market.

Cryptocurrency-collateralized stablecoin is similar to fiat-collateralized stablecoin but uses another form of cryptocurrency as collateral instead of using fiat money. This form of stablecoin is more price-volatile; as a result, it is frequently over-collateralized in order to keep the price stability. An example of this type of stablecoin is Dai, issued by MakerDAO. Dai, an alternative to Tether, is also U.S.-dollar-pegged but is not actually backed by the dollar. Instead, its value comes from collateralized Ethereum, where the users must first deposit a larger amount of ether in return for stablecoins. For example, the user deposits USD$250 worth of ether (ETH) for $100 worth of stablecoins. The coins, in this case, are 250% over-collateralized, which means that even if the price of ether drops by 50%, there is still USD$125 worth of ether to back the $100 worth of stablecoins.

Non-collateralized stablecoin is not backed by any other currency or asset, but is rather valued using a pricing algorithm and assumed (or hoped) that its value will remain unchanged.

In other words, it is based on a price mechanism that algorithmically creates upwards or downwards pressure. For instance, if the price moves above $1, the supply of stablecoins will increase, and if the price moves below $1, the supply of stablecoins will decrease, in addition to buying and selling tokens in parallel, in order to keep the price-parity stable to 1:1. This mechanism, issued by Basis, is comparable to a central bank’s money creation process, but in an algorithmic way, where the non-collateralized peg is adjusted automatically.

A global-growth stimulus

Let’s return to the problem of the massive number of unbanked or underbanked consumers in developing countries. Cryptocurrency can help spur global growth. While a staggering number of consumers in emerging and frontier markets do not own bank accounts, they are no strangers to technology.

Developing countries in Africa, Asia, and South America have seen explosive growth in smartphone ownership since 2013, from a median of 21% to 37% in 2015. China alone had 731 million internet users as of December 2016, and 95% of them are on mobile, which represents more than half of the country’s population to use internet on a smartphone. Furthermore, in India, the second most populous country in the world, the number of smartphone users will grow by c.16% in 2018, accounting for more than a quarter of the country’s population. Even in Myanmar, the poorest country in South-East Asia, more than half of all adults have smartphones.

This means that blockchain-based smartphone apps could transform the lives of poor people by opening doors to the consumers in these regions that traditional banking has left behind – helping poor people gain access to financial services.

Easier and faster access to electronic payments (and to financial services in general) will not only help more people contribute to economic growth, but it will also help them build personal financial histories. This, in turn, can help create an overall better quality of life for them.

SMEs are often referred to as the backbone of an economy. Cryptocurrency can help empower the entrepreneurs behind SMEs by combining the digital technology and financial services necessary to grow these businesses. Not only can cryptocurrency have a positive effect on the local economy, it also has a potential international reach. Global consumers can use it to pay for goods and services on the other side of the world without the hassle of dealing with exchange rates.

Cryptocurrency’s Achilles heel is its price volatility. There is a need for cryptocurrency that is impervious to price fluctuations. Stablecoin could be the solution.

Lori Griffin, freelance financial writer