With the recent rise of stablecoins over the last year, people start questioning why do we need so many and what are they all for. In this post we’ll try to explain the core distinctions in different types of these assets, and why we believe algorithmic stablecoin is one of the best options to choose from.
Why stablecoins?
The basic need for stablecoin was created quite a while ago, simply due to inevitable and evident habits of cryptocurrency traders and investors. The primary function of such asset is to allow people to hedge their risks in times of extreme volatility and uncertainty in the market without compromising liquidity issues. In simple words, you become more flexible with your crypto holdings and can plan your investment/trading strategy in advance.
On top of that, most of the companies who issue stablecoins try to integrate them with a variety of useful services, including payments, settlements, insurance, lending, remittance, wealth storage and even salary payouts. Over time we expect to see every major company using stablecoins just as comfortably, as they are using credit card payments. This may contradict with the original vision of Bitcoin but sometimes we have to adjust to realities and the needs of the market.
Why so many?
According to The State of Stablecoins report by Consensys, there are over 200 stablecoins to date. It’s a lot. This number makes it more challenging to make a decision of which one to use. The rule of thumb is you go for those that are backed by a big reputable company or a team of people that proved to deliver the results they promised.
The good news is, there are only three types of stablecoins that you should be aware of:
1) Fiat-collateralized. Usually backed by financial institutions. This means that each coin is backed by the real money in a bank account or cash equivalent. Basically, it creates a bridge between the real world and the digital one. The examples of such projects are Tether, USD Coin, Gemini, TUSD, PAX, Libra (upcoming).
2) Crypto-collateralized. These are backed by one or several digital assets, instead of banks/cash. Apparently crypto tokens are quite volatile, which is why most of such stablecoins use an approach called Collateralized Debt Positions (CDPs), something we discussed in depth during Zigzag introduction. The biggest benefit of CDP is that it gives investors access to extra capital in the form of Dai, without having to sell their crypto to get it.
3) Non-collateralized. This type is the most interesting one, it includes projects that leverage Seigniorage Shares, Decentralized Bank or Algorithmic stabilization mechanisms. Typically, they rely on combination of collateralized positions, automatic supply balancing techniques.
As you can see, each type has its own benefits and drawbacks but in the end they provide almost the same value proposition. The reason people keep creating more projects like these is simply because everyone wants a piece of a big pie. From Bitcoin forks, to Ethereum tokens, to Exchange coins, this is all a game of who adds more value to the customers.
Algorithmic stablecoins
The most impressive type of stablecoins we put our major focus on is the one that is based on algorithm balancing a circulating supply of the asset itself. In simple words, it issues more coins when the price rises and reduces supply when the price falls.
For example, assume a stablecoin is worth $1. When it drops to $0.80, an algorithm recognizes the imbalance between supply and demand, and automatically sets a market buy order to push the price back. In case the price goes above $1, the algorithm sells assets to maintain the price on agreed level.
A described model is based on something called the quantity theory of money introduced in 1517 by Polish math scientist. It is also used by central banks to manipulate the value of its national currency, something the governments shouldn’t be proud of.
One of the examples of algorithmic stablecoin is the project maintained by our team, Zigzag. We are putting a lot of efforts to create more usability and vivid use cases for this token, so stay tuned for updates in upcoming weeks.
