What Is Stablecoin? Different Types Of Stablecoins In 2021

Governments across the globe have become wary of the size of the stablecoin market. Due to this, a lot of banks often, intermittently, disable the payments to fund your crypto wallet. While working an algorithm-based stablecoin is fairly complex, there has been little success in making them mainstream. Given the last experiment of Terra-Luna that led to wealth destruction of $50B, the future looks bleak for them.

You already know that crypto could do it but quite often you cannot stomach the volatility. They offer you to hold relatively safer assets on a blockchain-based platform. Some of the protocols also offer interest to deposit your stablecoins with them. Seignorage are the only category of stablecoins which are not backed by any asset. Seignorage-style coins utilize an algorithmically governed approach to expanding and contracting a stablecoin’s money supply, just like how a central bank prints or destroys money.

As most other similar systems, MakerDAO team developed their stablecoin on the Ethereum blockchain. To maintain price stability, the team decided to use a complex system of multi-collateral smart contracts, and two native cryptocurrencies, and . The arrival of cryptocurrencies marked the introduction of completely new financial instruments. Crypto assets such as Ethereum and Bitcoin could present high levels of volatility, thereby calling for instruments to boost stability. Subsequently, the demand for stablecoins escalated in recent years with profound growth since July 2017. Stablecoins offers the most reliable solution for hedging funds in event of extremely volatile crypto prices.

What Is Swing Trading And How Does It Work?

At the same time, the operating model of these coins is done on-chain through smart contracts instead of depending on a centralized issuer. Different stablecoin classifications exist, but in this article we are going to sort stablecoins in three categories, primarily based on the type of assets they use as collateral. All three types rely on differing degrees of centralization and use different stabilisation mechanisms in order to maintain their intended peg.

Generally, people look for investment in precious metals, valuable assets, or exclusive real estate for preservation of their wealth. Fiat-backed stablecoins, for instance, are popular because they are as stable as the U.S. dollar or other widely accepted currencies. As the name describes, commodity-backed stablecoins are pegged to the value of commodities like precious metals, industrial metals, oil or real estate. Commodity investors love the option of commodity-backed stablecoins because it allows them to invest in gold without the hassle of sourcing and storing it.

The U.S. dollar, for example, is fiat currency (though it used to be non-fiat when it was backed by gold). Stablecoins might be best thought of as tools to use in an emerging DeFi system instead of other types of assets. These coins let traders and users of DeFi apps interact with a form of fiat currency directly on the blockchain. The design of Binance USD can serve as helpful for different types of commerce while also ensuring better speed of transactions.

Seniorage shares use a smart contract to mimic a central bank in which the monetary policy has only one obligation, issue a currency with a value of $1. In other words, the network issues new coins if the price of the stablecoin is too high, and burns coins if the price is too low. Assume that you have to deposit almost $1000 worth of Ether for obtaining $500 worth of stablecoins. Therefore, you can see that stablecoins are 200% collateralized, thereby implying the possibility of enduring a price drop of 25%. After the price drop, you would still have the $500 worth of stablecoins, albeit with the backing of $750 worth of Ether.

What Are The Types Of Stablecoins?

Crypto-backed stablecoins, on the other hand, paint a very different picture than those pegged to crypto assets. There is a complete list of stablecoins available today, including crypto-backed stablecoins. It is possible for stablecoins to maintain overcollateralized positions under certain circumstances. Tether is the most popular stablecoin in terms of daily trading volume and the third largest cryptocurrency by market cap at the time of writing according to Coinmarketcap.com. Launched in 2014, USDT is one of the oldest stablecoins in the crypto market.

Separate tokens are responsible for creating the DGX token for retaining the identification of the gold bar against which it is pegged. The token known as the Proof of Asset is administered through a smart contract involved in the creation of the DGX token. Any holder of DGX could cash out their DGX in real physical gold bars according to the specified value. At present, there are almost 200 million DGX tokens available, and the stablecoin has plans of expanding beyond a single vault in Singapore. The team behind the foundation of True USD includes members from Google, UC Berkley, Palantir, and Stanford. On the contrary, it enjoys a reasonable market capitalization of $7.5 billion if not close to that of Tether.

A report detailing the present reserve positions of the corporation has subsequently been made public by those responsible as an act to foster transparency and reliability. It is important to keep in mind that the valuation of the U.S. dollar was formerly guaranteed by gold, but then that guarantee was removed many generations earlier. Despite this change, the value of the dollar remained unshakeable because people continued to trust in its worth. A similar concept may be used to stablecoins that do not have collateral backing. Decentralization is the most important characteristic among the stablecoin subcategories.

The non-collateralized stablecoins, also known as algorithmic stablecoins, use algorithms to manage the number of stablecoins in circulation. The fact that non-collateralized stablecoins really aren’t supported by anything may seem to be in contradiction with the nature of stablecoins; nevertheless, this is not the case. Unlike bitcoin, commodity-based stablecoins hold a tangible asset to back their value. Creating tokens that represent a physical asset can open windows to new businesses. Furthermore, stablecoins do not remain bound to geography which increases liquidity, transparency, and efficiency. So, an algorithmic stablecoin, as said previously, maintains a peg via a smart contract regulating supply and demand.

Remittances, Banking, And Financial Ecosystem

If the market price of the stablecoin falls below the price of the fiat currency it tracks, token supply is reduced. If the price of the stablecoin rises above the price of its pegged fiat currency, the algorithm increases token supply to put downward pressure on the stablecoin value. With the tethering done on-chain, it is not subject to third-party regulation creating a decentralized solution. Stablecoins are typically pegged to a currency or a commodity like gold, and they use different mechanisms to maintain their price peg.

There really is no collateral available to convert the currency back in the case of a significant market decline. Using this form of digital currency enables inclusive financial services to those left out of our current ecosystem. Not bound by conditions, stablecoins can render financial relief to the unbanked or unidentified people in the system. In other words, say if there are $100,000 coins in circulation, the subsequent amount should be held in bank reserves.

When the price of cryptocurrencies keeps rocketing higher, this volatility is welcomed. The price stability is achieved through introduction of supplementary instruments and incentives, not just the collateral. Unlike the other stablecoin types discussed here, algorithmic stablecoins aren’t backed by other assets. Decentralized algorithmic coins are a newer technology and differ from the other types of stablecoins in that they don’t involve any type of collateral backing. However, coins pegged to a fiat currency are the most commonly used type.

Bitcoin Vs Gold: Which Is Better?

It can ensure the assurance of reliable levels of transparency about details of its cash reserves. This type combines the features of a fully algorithmic and fully collateralized stablecoin. These stablecoins avoid over-collateralization and have less custodial risk. In contrast to typical algorithmic designs, this type aims to maintain a tighter peg with a higher level of stability. As the name says, these stablecoins are backed by other cryptocurrencies.

• The two largest stablecoins by market capitalization, Tether & USD Coin , fall in this category.
• DAI also presents a unique trait in the fact that it is an Ethereum-based ERC-20 token.
• When it comes to controlling the number of stablecoins, these kinds of coins make use of a method that is algorithmically managed.
• Most stablecoins on the market use the US Dollar as their reference point, and are supposed to keep their valuation as close as possible to $1 at all times.
• Dai is the stablecoin with which you lock up Ether in a collateralized debt position or CDP.
• An example was when the SEC rejected Bitcoin ETF’s proposal from Winklevoss Brothers; many traders sold their cryptocurrencies for Tether in order to preserve their investment value.
• CarbonUSD, created by Carbon, is another stablecoin implementing a non-collateralized price stability mechanism.

Such is the case with the Pax Dollar and Gemini Dollar , two USD-backed stablecoins that are regulated by the New York State Department of Financial Services. The interesting highlight about Palladium Coin is the comprehensive automation in the whole purchasing system. Furthermore, users could also request for cashing out your stablecoin in actual physical palladium. It is also important to note that you have to compromise on your anonymity when requesting physical palladium. They act as a stabilizing force in an otherwise volatile cryptocurrency ecosystem and provide increased liquidity that is always welcome.

Fiat Baked Stablecoins

You see, there are many What is a stablecoin and how it works, each with separate working mechanisms, pros and cons. Let us study the four main types of stablecoins in the following paragraphs. Stablecoins can also be collateralized by cryptocurrencies, which means that these assets are backed by other crypto assets, not fiat currency. Given that the cryptocurrency reserves that support stablecoins are also vulnerable to high volatility, these stablecoins are over-collateralized. This condition also indicates that the value of cryptocurrencies stored in reserve exceeds the value of the issued stablecoins. Stablecoin is a class of crypto assets which its value is pegged or tied to a currency, commodity, or other financial instruments.

The first method stablecoin issuers use to make money is through the straightforward charging of redemption and issuance fees. Stablecoins are cryptocurrencies that keep their value stable in relation to another asset — most commonly, an existing fiat currency, such as the U.S. dollar. It’s distinguished as the first regulated blockchain infrastructure platform for financial services. Paxos’ products are helping to https://xcritical.com/ build the foundation for a decentralized financial system that can operate faster and more efficiently than the current legacy systems. DAI is a decentralized stablecoin governed by the Maker Protocol and its smart contracts, which in turn is governed by a community of MKR token holders. The overall functions remain the same, but the value is tied to the current price of gold, with physical gold used as collateral.

As the name clearly implies, commodity-backed stablecoins have the backing of different types of interchangeable assets such as precious metals. The most common commodity used as collateral for commodity-backed stablecoins is gold. This type of stablecoins is often centralized because a central authority periodically maintains the reserves and gets them audited from a third party. For example, Tether holds the right to issue or burn the USDT in the market. Most of the centralized fiat-backed stablecoins work through the model of maintaining a reserve. Such stablecoins are backed by other cryptocurrencies like bitcoin and ethereum.

While this can be done for other cryptocurrencies as well, stablecoins often offer a simpler transaction that is unlikely to fluctuate while you are completing the process. Secondly, it offers greater flexibility to buy other cryptos as most trading pairs are available with stablecoins. Say market conditions are getting worse and you want to sell your holdings. At the same time, you don’t want to be taxed yet as you plan to get back in once the storm settles. One may argue that what is the point of a crypto stablecoin if they are going to be pegged against a centralized inflationary asset like USD?

What Are The Different Types Of Stablecoins & How Do They Work?

These stablecoins are used as functional currency within a crypto brokerage. This Network helps to scale Ethereum by introducing Layer 2 proof-of-stake side chains which parallel the main Ethereum network. Polygon helps to increase Ethereum’s efficiency by reducing costs and increasing transaction throughput. Most of the blockchains you have heard of fall into the public category. This means that they are not unique and can be interchanged freely, sort of like how one US dollar is as good as the next.

Each stablecoin variant has its unique characteristic, i.e., the collateral for backing the stablecoin. Furthermore, certain crypto-backed stablecoins also have the backing of multiple cryptocurrencies for ensuring efficient risk distribution. Additionally, crypto-backed stablecoins also have the advantage of improved liquidity.

Guide To Stablecoin: Types Of Stablecoins & Its Importance

These reserves are often audited by reputed firms; hence, people trust these companies. While a lot of players are trying to achieve this, there has been little to no success. One failed cryptocurrency which tried achieving this is $LUNA from the Terra ecosystem. Hedging – or ‘hedge’ – simply means to reduce the risk of adverse price movements in an investment or asset. Hedging is a strategy often used in the investment world to protect your positions by reducing risks. There are many ways to reduce risks, such as having a balanced portfolio mix of ‘safe’ and ‘risky’ investments.

However, True USD leverages the Trust protocol, which has profound regulatory backing alongside efficient guidance of fiduciary actions. Reported that the overall market capitalization of Tether amounts to more than $32 billion. It will be interesting to observe which stablecoin method will prevail in the end as all three models have their advantages as well as shortcomings.

For instance, MakerDAO is one of the most popular crypto-backed stablecoins. It uses a smart contract – a type of self-executing, code-based contract – alongside the Ethereum blockchain to pool enough ether to use as collateral for its stablecoin. Then, once the amount of collateral reaches a certain level in the smart contract, users can mint DAI – the MakerDAO stablecoin. Others, known as non-collateralized stablecoins, do not have reserves backing them but instead create security via the use of algorithms.

Author: admin