Stablecoin: Understanding types & Differentiantions

The world is progressively accepting the fact that cryptocurrency is here to be. Starting from the first splash it made with Bitcoin in 2009, the industry is continually developing and seeking new, better solutions. The introduction of stablecoins has helped to eliminate a huge problem with the volatility of crypto assets.

In this article, we will go through the main types of stablecoin collaterals and describe how they work, in order to help you understand the technology better.

What is Stablecoin? 

Stablecoin is a blockchain-based currency attempting to make a stable value of digital assets. Such a solution allows holders to transfer a certain value anywhere on the globe rapidly and benefit from its security and resilience.

In other words, stablecoin has a variety of cryptocurrency advantages such as programmability, open data access, high speed, extremely low transaction price, or its absence while eliminating the major issue with volatility. This stability can be ensured because stablecoin value, unlike bitcoin or Ethereum, is tethered to certain assets such as gold or US dollars.

Therefore, even in the case, any drastic decline of equity happens, the controlling authorities can step in and maintain the value stability by managing supply and demand rates. 

Mechanism of Stablecoin

Stablecoin has a few working mechanisms, depending on the value it is pegged to. Let’s define them in a more precise way.

Fiat-backed stablecoins

One of the first and most known is fiat-collateralized stablecoin. This type of stablecoin is backed directly by one of the existing fiat currencies, such as the US dollar, GBP or EUR. In this case, fiat-currencies are used as collateral and guarantee the stability of value.

Tokens are issued with an exchange rate of 1:1, meaning 1 fiat-baked stablecoin is equal to 1 US dollar. If someone wants to withdraw a certain amount of assets from the reserve, the same amount of stablecoins will be destroyed then and taken out of circulation. Tether (or USDt) is the most prominent example of fiat-backed stablecoins. There list also contains USD coin (USDc), True USD (TUSD), Paxos standard (PAX), etc.

Due to its simplicity, this type of stablecoins is the most common on the market. The best example of fiat-collateralized coins is Tether, which has a trading volume of around 95% of the whole market. 

Crypto-backed stablecoins

The next type is crypto-collateralized coins which are backed by one of the existing cryptocurrencies. To reduce price volatility, in this case, crypto-backed stablecoins are usually double collateralized by the reserve currency.

For example, if you want to get $500 worth of stablecoins, you need to collateralize it with the amount of $1000 of Ether or other valuable crypto assets. Such kind of solution appears due to cryptocurrencies’ instability and a high level of fluctuation. MakerDAO DAI is one of the well-known examples for this type of stablecoins.

It seems that crypto-collateralized stablecoins are more trustworthy because of the lack of any authority behind them. Moreover, all transactions remain in blockchain ecosystems, which makes them even more transparent and secure. 

Commodity-backed stablecoins

Commodity-collateralized coins are backed by physical assets, such as gold in most cases. Another example of a commodity used as collateral can be diamonds, oil, other types of precious metals, and, even, real estate (in Switzerland).

Before the stablecoin revolution, those types of goods were held just for the purpose of being, yet recently it faced a new way of usage and investing. The mechanism of commodity-backed stablecoins is similar to fiat-collateralized ones, yet here stablecoin value is pegged by a certain amount of chosen commodity.

For instance, in the case of DGX (Digix Gold Token) which is backed by gold stored in Singapore, 1 stablecoin is tethered to 1 gram of gold. One of the main advantages of using this particular mechanism of stablecoins is that the collateral, in this case, has real value. And furthermore, the value of such may increase over the years. 

Algorithmic stablecoin

The last type of stablecoins is one of the most promising, yet controversial at the same time. Algorithmic stablecoins are usually called non-collateral or implicit collateral due to a lack of actual assets pegged to them. The same as today’s dollar, which is not backed by equal amounts of gold, its value maintains because of people’s beliefs and expectations.

All operations, regarding algorithmic stablecoin, are fully decentralized and do not need any custodian to authorize it. The mechanism of smart contract manages the token supply automatically, it reduces or increases token emission in order to ensure the stable value of the tracked fiat currency. The strength of such a solution does not lie only in its full autonomy and decentralization; the system ensures that even in case of total market destruction, algorithmic stablecoins survive and will not lose their value. 

Conclusion

If before we should have talked about fiat-currency and crypto worlds as two separate ecosystems, this is not the same anymore tanks to the stablecoin successful adoption.

Which type of stablecoin to use is your choice, our mission in Blaize is to ensure the usage of best technologies and experts in order to fulfill your project. In terms of development, Blaize can offer the initial creation of stablecoin using any of the described mechanisms, as well as, the integration of any existing solution into your business case.

Contact Blaize to discuss further opportunities of stablecoin development for your project!

Well, if you need a solution that gives the opportunity to simply and at the same time safely exchange or make transactions with coins tethered to any existing fiat currency or you search for stability in crypto-assets then creation of your own stablecoin is the best solution.

Post author

Sergey Onyshchenko

Co-founder & CEO of Blaize

Expert on decentralized finance, governance, policies and blockchain technologies.