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Stablecoin Primer Section 3— Stablecoin types

Did someone say central bank on a blockchain?

Types of stablecoins by diedamlas

Two mental models

  • Two different types of stablecoin users: Consumers and DeFi participants (DeFi =decentralized finance). A consumer is someone who simply wants to buy and hold stablecoins. For example, someone who only uses stablecoins to convert their salary into DAI or USDT to save in dollars could be considered a consumer. Consumers usually interact with stablecoins only via secondary markets such as using a fiat-to-crypto exchanges to buy / sell stablecoins. If you identify as a consumer and are not necessarily curious about the systems behind stablecoins, you do not have to worry about the intricacies of stablecoin protocols — feel free to just skim through the sections until Section 5. A DeFi participant, on the other hand, leverages stablecoin protocols to mint (create) stablecoins and participate in various DeFi activities such as yield farming. A range of parties could counted as DeFi participants including but not limited to traders, institutions, crypto exchanges, and DAOs. Understanding how a DeFi participant interacts with a stablecoin protocol is crucial because without them, stablecoins do not exist. If you identify as a DeFi participant or are interested in the nuts and bolts of stablecoins, this section is perhaps relevant and useful for you. Enjoy!
  • Stablecoin protocols are like financial institutions that run on code: Like I said, stablecoin protocols are complex. I think a helpful and over-simplified way of thinking about them is the following: stablecoin protocols, especially the decentralized ones, are like banks that operate on code (i.e., blockchain) and tokens are critical to how these protocols operate. As simple as that may sound, if you don’t have a finance background or are not interested in the inner workings of financial institutions, it may not be all too intuitive to you how banks work. Add another layer of complexity on top of that thanks to blockchain and tokens. That’s why I think expecting some complexity to start with is helpful.
Two different stablecoin users and a stablecoin protocol by diedamlas

Design Principles

Overly-simplified stablecoin mission control deck by diedamlas
Total market cap of stablecoins currently stands at+$186 billion. Source: CoinMarketCap

1- Fiat-backed stablecoins

Fiat-backed stablecoin issuance by diedamlas
Total market cap of fiat-backed stablecoins currently stands at +$155 billion, account for ~85% of the total stableocin market. Source: CoinMarketCap
Mission control deck for fiat-backed stablecoins by diedamlas. High stability, low decentralization, medium capital efficiency.

2- Crypto-backed stablecoins

Crypto-backed stablecoin issuance by diedamlas
Total market cap of crypto-backed stablecoins currently stands at +$13 billion. Source: CoinMarketCap
Mission control deck for crypto-backed stablecoins by diedamlas. High stability, high decentralization, low capital efficiency.

3- Algorithmic stablecoins

Algorithmic stablecoin issuance by diedamlas
Total market cap of algorithmic stablecoins currently stands at +$19 billion. Source: CoinMarketCap
Mission control deck for algorithmic stablecoins by diedamlas. Low stability, high decentralization, high capital efficiency.
  • Dollar access: People around the World want to transact and save in US dollars. Dollar denominated fiat-backed stablecoins are simply a faster and easier way to get dollar exposure compared to traditional banking channels.
  • Familiar mechanism: At the end of the day, people will ask “so, how does this work?”. It’s quite easy to explain the reserve mechanism of fiat-backed stablecoins, and that simply builds trust.
  • Early entry: Tether has been operational since 2015, and has grown its popularity following the 2018 ICO boom. People are just familiar with USDT and hence other fiat-backed stablecoins.



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Osman Sarman

Engineer and ex-consultant exploring stablecoins, twitter: @_namsso_