Augment Labs Learn Series: Stablecoins Basics
The Types of Stablecoins and What is USC
Stablecoins are one of the most widely used assets in decentralized finance (DeFi). Their main purpose is to maintain a stable value relative to a particular asset or benchmark for users to safely store value in them.
However, each of them in the market are designed differently with various designs and a variety of adjustments in terms of their collateral backing and stabilising mechanism.
This article will take a look at the ways stablecoins are designed, focusing on the overarching three main types and we will dive into where our stablecoin USC stands in the ecosystem.
The three main types of stablecoins in the crypto market are:
- Fiat-collateralized
- Crypto-collateralized
- Algorithmic (seigniorage)
Each stablecoin family suffers inefficiencies in design stemming from the “Stablecoin Trilemma.” This trilemma forces stablecoin designers to focus on mechanisms that can sacrifice either decentralization, price stability, or capital efficiency.
Fiat-collateralized Stablecoins
Fiat-collateralized stablecoins are the most popular and simplest type of stablecoin. They are pegged to a fiat currency, such as the US dollar or Euro, and are backed by reserves of that currency held by the issuer. The value of these stablecoins is maintained by the issuer holding an equivalent amount of the underlying currency in reserve. For example, if a fiat-backed stablecoin is pegged to the US dollar, the issuer holds US dollars in reserve equal to the total amount of stablecoins in circulation. This ensures that the stablecoin’s value remains stable and closely tracks the value of the underlying asset.
Crypto-collateralized Stablecoins
Crypto-collateralized stablecoins are backed by other cryptocurrencies or digital assets. The reserves are typically held in smart contracts that ensure the value of the stablecoin is maintained. For example, a crypto-backed stablecoin may be backed by Ether (ETH), Bitcoin (BTC) or a mix of cryptocurrencies. The smart contract ensures that the value of the stablecoin remains stable by adjusting the amount of the reserve asset held in reserve relative to the number of stablecoins in circulation.
Algorithmic Stablecoins
Algorithmic stablecoins, also known as seigniorage-style stablecoins, use algorithms to adjust the supply of the stablecoin in response to changes in demand in order to maintain a stable value. They do not rely on reserves of any underlying asset to maintain their value. Instead, the algorithm controls the supply of the stablecoin based on market demand. For example, if the market demand for a particular algorithmic stablecoin increases, the algorithm would increase the supply of stablecoins to bring the price back down to its target value. Conversely, if the market demand for the stablecoin decreases, the algorithm would decrease the supply of stablecoins to bring the price back up to its target value.
Benefits & Risks of The Types of Stablecoins
Each type of stablecoin has its own benefits and drawbacks. Fiat-backed stablecoins are the most widely adopted and offer the most straightforward approach to maintaining a stable value. However, they require trust in the issuer to maintain an appropriate reserve and can be subject to regulatory scrutiny like what we saw earlier last week with BUSD and Paxos.
Check out our first article where we covered the risk of centralisation of these stablecoins here.
Crypto-backed stablecoins offer a more decentralized approach and can be less subject to regulatory scrutiny. However, the value of the underlying cryptocurrency can be highly volatile, which can impact the stability of the stablecoin.
Lastly, algorithmic stablecoins offer a highly decentralized approach but can be highly complex and subject to a variety of risks, including potential algorithmic errors and market manipulation that we saw happen to LUNA UST that resulted in its bank run and eventual failure.
Where does USC stand?
USC is considered an algorithmic stablecoin with a dual token structure with AGC as the governance and treasury asset for USC.
How does USC work?
The design of AGC and USC is centered around an algorithmic stabilization mechanism that ensures the stable value of USC, while providing a stable source of demand for AGC. The stabilization mechanism involves issuing new USC tokens and selling them for AGC when the price of USC rises above $1 USD, and buying back USC and burning it when the price of USC falls below $1 USD.
On top of that, we have a key component to the design, Automated Market Cap Comparison Framework, which is a dynamic price oracle that will monitor the ratios of the stablecoin USC and its collateral, and adjust the price of USC to prevent inverted pressure on AGC. Additionally, 80% of USC inflow capital would go to a collateralized insurance fund to support AGC’s market capitalization. This ensures the stability of USC.
On top of that, we will also have a staking/yield function with a 10–20% APY funded by the fees we collect from our various web3 gaming protocols and debit card(launching soon). This helps to continually attract liquidity even during periods of duress, reducing the sell pressure on the stablecoin and potentially can drive further adoption for USC in the long run.
Our specific design for AGC USC creates a self-reinforcing cycle of stability and demand for AGC, and at the same time takes into account the potential bank run scenario during risk off markets and have the necessary mechanisms in place to ensure that it maintains peg regardless of market condition. This all-rounded stablecoin design has the potential to revolutionize the world of stablecoins and DeFi.
As we move towards launch, we will be sharing more on our developments and the various use cases we will be building for it. We will also be apart of the upcoming Blockchain Life Conference in Dubai! Stay tuned!
Join us in our push towards a truly decentralized stablecoin ecosystem for DeFi to thrive.
