Briefly describe the types of stablecoins and the importance of decentralized stablecoins

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Fiat-collateralized stablecoins accounted for most of the market share of the cryptocurrency market, but decentralized stablecoins followed closely and grew rapidly.

Original title: “Viewpoint丨Why are decentralized stablecoins so important? 》
Written by: NOWNodes
Translation: Olivia

Before delving into the topic of decentralized stablecoins, let’s do a review of stablecoins. So, what exactly is a stablecoin? It is a type of cryptocurrency. But unlike most cryptocurrencies, the value of stablecoins is linked to the legal tender of one or more countries . Not only are national currencies, some stable currencies are also linked to physical assets. Therefore, stablecoins are cryptocurrencies whose value is backed by one or more financial assets .

Types of stablecoins

The category of stablecoins is based on assets that support the value of stablecoins. There are four types of stablecoins:

  1. Legal currency mortgage stable currency
  2. Commodity mortgage stablecoin
  3. Encrypted asset mortgage stable currency
  4. Algorithmic stablecoin

Legal currency mortgage stable currency

When it comes to the most common types of stablecoins, fiat-collateralized stablecoins dominate the stablecoins . The value of these stablecoins is backed by one or more legal currencies. The most popular fiat currencies used here are the U.S. dollar, euro and pound sterling .

Each legal currency mortgaged stable currency is linked to the corresponding legal currency at a ratio of 1:1. For every stable currency in circulation, an equal amount of legal currency is required to support it. The amount of stable currency backed by fiat currency collateral is usually deposited in a bank account .

Let’s say someone has a stablecoin backed by 100 dollars. Now, he wants to redeem the stablecoin with the same amount of dollars. Therefore, the company that manages the stablecoin will transfer $100 into his bank account through their reserves. So, what happens when this person exchanges a 100-dollar-backed stable currency for fiat dollars? The answer is to remove the $100-backed stablecoin from the circulation.

Commodity mortgage stablecoin

Commodity mortgage stablecoins are not backed by currencies, but by assets such as precious metals. Facts have proved that gold is the most common commodity in the field of commodity-collateralized stablecoins . Other assets such as real estate, other precious metals and oil are also used as collateral to create commodity-backed stablecoins.

The advantage of holding a commodity-collateralized stablecoin is that its holder actually owns a share of something with real value-unlike most cryptocurrencies. If the price of mortgage assets rises in the future, holders of such stablecoins can also benefit from it .

Encrypted asset mortgage stable currency

Crypto-asset-collateralized stablecoins are backed by major cryptocurrencies such as Bitcoin and Ethereum . These types of stablecoins are more decentralized than those supported by currencies and various commodities. Among them, over-collateralization is a major feature of encrypted assets mortgage stablecoins . Why do you say that? Because it plays a role in hedging the risk of price fluctuations and helps encrypted assets mortgage stablecoins to absorb price fluctuations.

For example, to obtain $100 worth of encrypted assets collateralized stablecoins, you must deposit $150 worth of ETH. As you can see, the mortgage rate here is 150%. Now, even if the price of the underlying asset falls, the stablecoin can withstand the price depreciation. But if the price drop is low enough, the system will automatically liquidate the stablecoin .

Do you want trustless, safe, and transparent stablecoins? Encrypted asset collateralized stablecoin is your best choice. Because they are more decentralized than currency and commodity-backed stablecoins. When it comes to crypto-asset-backed stablecoin funds, there is no entity that issues the order. But they are still able to spread risks well, because they are usually backed by multiple cryptocurrencies.

If you choose these types of stablecoins, you will also benefit from their higher liquidity. These stablecoins can also be converted into basic encrypted assets at a cheap price, but at the same time they are also one of the most complex stablecoins. Therefore, so far we have not seen the attractiveness of cryptocurrencies supported by fiat currencies.

Do you know which crypto asset collateralized stablecoin is the most popular? You must have heard of it—it is Dai of MakerDAO. It is a stable currency whose value is backed by multiple crypto assets such as ETH . The face value of Dai is pegged to the U.S. dollar, and the pledged ETH is held in the form of a smart contract.

Algorithmic stablecoin

It has been revealed from their names that there is no asset backing the value of unsecured stablecoins . This may surprise many people to think about what a stable coin is. Take the U.S. dollar as an example-in the past every dollar was backed by gold. But the situation has changed, and the dollar has had no support in recent decades. Has the dollar started to become unstable? of course not! Algorithmic stablecoins also use the same concept.

The seignorage model is the core of the algorithmic stablecoin supply work. The principle is to control the supply of these stable coins through algorithmic governance . If the demand for algorithmic stablecoins increases, new coins will be produced. This leads to a reduction in prices, which will soon return to normal levels. When the price of an algorithmic stablecoin becomes too low, the opposite happens. You can see that the market supply and demand relationship keeps the prices of these stablecoins stable.

When it comes to decentralized stablecoins in the market, algorithmic stablecoins account for the majority. Even if fiat currencies such as the US dollar or the euro collapse together with the crypto market, algorithmic stablecoins will remain strong and survive the crash. But algorithmic stablecoins have a big problem- once they collapse, stablecoin holders will not be able to liquidate. Because this type of stable currency does not involve any collateral .

So, which type of stablecoin is decentralized? Crypto-collateralized and unsecured stablecoins are the real decentralized stablecoins. Let’s take a look at Dai again, because it is currently the most popular decentralized stable currency in the crypto market.

Quickly understand Dai—the most popular decentralized stablecoin

DAI is an encrypted asset mortgage stablecoin as described above, and it is an ERC20 token. Dai is the core part of MakerDAO’s lending platform . All MakerDAO users need Dai to borrow and repay. At the same time, you can easily transfer Dai between Ethereum wallets.

The smart contract will be executed automatically to control the price of Dai. When the price of DAI rises by more than $1, the Maker token (MKR) will be burned. If the price of DAI drops significantly against one dollar, then more DAI tokens will be created to stabilize the price.

In fact, there is no need to rely on anyone to keep DAI stable—you must be wondering why this is so? The reason is that all work is done by MakerDAO’s algorithm, which means that the algorithm manages the price of DAI.

The thing about DAI is that DAI is only generated when one borrows from the MakerDAO platform. Once the loan is paid off, DAI will be destroyed . So, you can get DAI from MakerDAO’s Oasis platform loan. This is the most direct way to obtain DAI. Another way is to trade DAI on MakerDAO’s Oasis platform. Similarly, you can also trade DAI on any centralized exchange.

Why is decentralized stablecoin so important?

Speaking of decentralized stablecoins, their operations and funds are very transparent , so we can rest assured of the entire operation process. Because all the details of their funds are on the public blockchain, everyone can verify it.

Stable coins play a very important role in the crypto trading market. Traders and crypto enthusiasts who are afraid of the volatility of cryptocurrencies can still participate in the crypto industry through stablecoins. They can hold stablecoins because they are not as volatile as other cryptocurrencies.

in conclusion

Up to now, fiat-collateralized stablecoins have occupied the largest market share in the cryptocurrency market . But decentralized stablecoins are closely following currency mortgage stablecoins. We expect decentralized stablecoins to continue their growth momentum. With the increasing popularity of DeFi, it is only a matter of time before decentralized stablecoins surpass fiat-collateralized stablecoins in the market.

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