Understanding Stablecoins

Let’s run the gamut of Stablecoins → Collateralized & Non-Collateralized.

What are Stablecoins?

During times of extreme volatility and uncertainty in the crypto markets, investors seek a safe haven for their capital. If they can’t realize a favorable ROI, the least they seek is to maintain their value. This can be achieved by exchanging their various cryptocurrencies for a stablecoin.

Stablecoins are a price stable cryptocurrency. Stablecoins are able to maintain their value by being backed by underlying assets, usually on a 1:1 basis (sometimes on a 1.5:1 ratio, over-collateralized).

These underlying assets could be fiat-currencies (or a basket of currencies), cryptocurrencies, precious metals, tangible assets (real estate, etc.) or a combination of the few.

While the promise of price stability is a great guarantee, the existence and maintenance of the underlying assets must be verified by a trusted third party in order to stay above board with investors and regulators.

Fiat-Backed (Collateral) Stablecoins

Fiat-backed stablecoins (Stably, TrueUSD) are price stable cryptocurrencies that are backed by fiat dollars in a third-party reserve bank which are regularly audited by another trusted third-party. Sometimes these stablecoins are backed by a basket or number of various world currencies. They are more often than not collateralized on a 1:1 ratio.

The first project to step into the space of stablecoins was Tether (USDT) in 2014. Tether claims to have a full reserve of cash to back the nearly 2.5 billion Tethers in circulation. They also claim to be fully transparent but there have been concerns raised about their methods of maintaining accountability.

This growing distrust with Tether has led to an exponential growth in stablecoin projects with the number reaching nearly 60 to date. Even large investment banks and institutions have jumped on the bandwagon and are exploring the use cases and benefits of this new spin on cryptocurrency.

Cryptocurrency-Backed (Collateral) Stablecoins

Cryptocurrency-backed stablecoins are stablecoins that are backed by other non-price stable cryptocurrencies, such as MakerDao who utilizes Ether as their underlying asset.

To prevent the breaking of the peg to $1 they have purposefully over-collateralized (1.5 : 1) the stablecoin so that if the price of the underlying asset, Ether, drops, they will liquidate the underlying position to free up the debt and maintain the peg or price stability.

Non-Collateralized (Algorithmic) Stablecoins

Non-collateralized stablecoins are those which are not backed by any underlying asset. Instead, they are stabilized and backed by smart contracts that “dynamically peg” their value by using algorithmic-central-bank style mechanisms.

Mixed-Asset (Collateral) Stablecoins

Mixed-Asset-backed stablecoins use a number of underlying assets in order to maintain their stability. They often utilize a combination of both fiat-currency and precious metals. There are also stablecoins who utilize tangible assets like real estate to stabilize their stablecoin.

Conclusion

Now that we have gone through the various types of stablecoins it should be easier for you to notice differences and similarities among them.

Each stablecoin has its pros and cons. Which type will we see the most success is still up for debate. As of now, the stablecoin projects that are collateralized by fiat-dollars seem to be gaining the most attraction.