Explaining stablecoins and Their Functions

Posted on: January 14, 2019

For each real-world asset-backed coin, an equivalent value in U.S. dollars or gold as an example is set aside in a bank. Trust is built and maintained in partnership with a centralized financial institution. This means real-world asset-backed coins should be fully and easily redeemable for their associated assets, and that coins should not be created and circulated except when this holds true. The most popular real-world backed (and overall) stablecoin, Tether, maintains an overwhelming percentage of the total stablecoin market capitalization, although this share has declined significantly–around 10 percentage points–at the end of 2018. Other notable real-world backed stablecoins include TrueUSD, USD Coin, Paxos Standard, and Gemini Dollar.

Crypto-collateralized coins

Crypto-collateralized coins are backed by other cryptocurrencies. Because cryptocurrencies are less stable than real-world assets, crypto-collateralized coins are over-collateralized. Whereas a U.S. dollar pegged stable coin would be pegged 1:1 (US$1 for 1 stablecoin), an ethereum backed stablecoin might be pegged 2:1 (US$2 worth of ethereum for US$1 worth of the stablecoin) to ensure stability even with large fluctuation. The primary crypto-collateralized stablecoin, MakerDAO, is pegged to the U.S. dollar, but backed by ethereum.

Uncollateralized or algorithmic stablecoin

The final type of stablecoin, uncollateralized or algorithmic stablecoin, is fully decentralized and is stabilized by algorithms dictating its value. These algorithms maintain value and stability by controlling the supply of the uncollateralized stablecoin–shrinking and growing it as needed. Basecoin is an example of an uncollateralized stablecoin: when the coin value dips below US$1, coin supply contracts (coin holders buy bonds using their coins, after which the used coins are destroyed) to increase the price, and the reverse holds true when the value exceeds US$1.