Bridging the best of both worlds.
Two primary reasons for the price stability of FIAT currencies are the reserves that back them and the timely market actions by the controlling authorities, like central banks. They are pegged to an underlying asset, such as gold or forex reserves, which act as collateral, stopping their valuations from experiencing wild swings. In extreme cases, the controlling authorities react by manipulating the demand and supply of the currency to maintain its price stability.
Most cryptocurrencies lack both of these key features — they don’t have a reserve backing their valuations and they don’t have a central authority to control prices when required.
Stablecoins are a class of cryptocurrencies which attempt to offer the best of both world’s — the instant processing and security of payments of cryptocurrencies, and the volatility-free stable prices of fiat currencies. There has been an explosion of stablecoins in recent times, boasting many different approaches.
Currency backed stablecoins
Currency backed stablecoins were the first type of stablecoins on the market. Their value is pegged to one or more currencies (most commonly the US dollar, but also the Euro and the Swiss franc) The tether is realized off-chain, through banks or other types of regulated financial institutions which serve as depositories of the currency used to back the stablecoin. The amount of the currency used for backing of the stablecoin has to reflect the circulating supply of the stablecoin.
The value of stablecoins of this type is based on the value of the backing currency, which is held by a third-party regulated financial entity. In this setting, the trust in the custodian of the backing asset is crucial for the stability of price of the stablecoin. Fiat-backed stablecoins can be traded on exchanges and are redeemable from the issuer. The cost of maintaining the stability of the stablecoin is equivalent to the cost of maintaining the backing reserve and the cost of legal compliance, maintaining licenses, auditors and the business infrastructure required by the regulator.
Tether (USDT), TrueUSD (TUSD), Paxos Standard (PAX), USD Coin (USDC), Gemini Dollar (GUSD) and Stasis (EURS) are all currency-backed stablecoins natively supported in Coinomi. They can be traded in-app by using one of our integrated instant exchange partners: Shapeshift boasts support for USDT and TUSD, while Changelly has support for all of them: USDT, TUSD, PAX, USDC, GUSD and EURS. Synthetix has promised more stablecoins pegged to different currencies (sEUR, sJPY, sAUD, sKRW), while Rockz (RKZ) is pegged to Swiss Francs. Our latest addition, CUSD, is a fiat backed interoperable stablecoin made by Carbon, a team focused on using AI and blockchain to increase access to financial services.
Commodities backed stablecoins
Stablecoins backed by commodities such as precious metals (gold, silver etc) are quite similar to fiat backed stablecoins. Their value is pegged to one or more exchange-traded commodities, in a fixed ratio. The peg is realized off-chain, through regulated financial institutions which serve as custodians of the commodity backing the stablecoin. The amount of exchange-traded commodity used to back the stablecoin has to reflect the circulating supply of the stablecoin.
Holders of commodity-backed stablecoins can redeem their stablecoins at the conversion rate to take possession of real assets. The cost of maintaining the stability of the stablecoin is equivalent to the cost of maintaining the backing reserve of the exchange-traded commodity and the cost of legal compliance, maintaining licenses, auditors and the business infrastructure required by the regulator.
The most prominent example of this category of stablecoins is Digix Gold Token (DGX), which is natively supported in Coinomi. Synthetix will also release a commodity-backed stablecoin sXAU, pegged to gold.
Cryptocurrency backed stablecoins
Cryptocurrency backed stablecoins are issued with cryptocurrencies as collateral, which is conceptually similar to fiat-backed stablecoins. In many cases, these work by allowing users to take out a loan against a smart-contract via locking up collateral, making it more worthwhile to pay off their debt should the stablecoin ever decrease in value. To prevent sudden crashes, a user who takes out a loan may be liquidated by the smart contract should their collateral decrease too close to the value of their withdrawal.
The value of the stablecoin is collateralized by an another cryptocurrency or a cryptocurrency portfolio. The peg is executed on-chain via smart contracts, while the supply is regulated on-chain, using smart contracts. The price stability is achieved through introduction of supplementary instruments and incentives, apart from the collateral.
The technical implementation of this type of stablecoins is more complex and varied than that of fiat-collateralized stablecoins, which introduces a greater risks of exploits due to possible bugs in the smart contract code. However, they are not subject to third party regulation creating a decentralized on-chain solution. Due to the nature of the highly volatile nature of cryptocurrencies, a very large collateral must be maintained to ensure stability.
Live stablecoins projects of this type are Synthetix (sUSD/SNX) and Maker (DAI/MKR). Both are natively supported in Coinomi. Users can trade DAI and MKR directly in-app using Changelly.
Seigniorage (algorithmic) stablecoins
This type of stablecoins use a decentralized autonomous organization (DAO) which controls issuance and pricing. These stablecoins are fully digitalized and are not relying on any types of collateral, with their supply and target price controlled only by the DAO. This feature makes the regulation fully decentralized without the need of any third party regulation. They are also highly scalable, since they don’t require additional collateralization when the supply increases, rendering the cost of price stability very low. Their peg is realised on-chain, and their supply is typically controlled by issuing and destroying coins depending on the market demand, until the target price is reached. In the general case, market participants are incentivized to act in a way that the price is kept at target level by issuing either bonds, in times of decreasing price or seigniorage shares when the price is above target.
Two of the oldest Seniorage Shares approach are Bitshares (BitUSD) and NuBits (USNBTS). However, they have both lost their peg recently. The latter is natively supported in Coinomi, and can be traded via Changelly, while the former is expected soon.
Basis, an algorithmic stablecoin that was expected this year, unfortunately cited regulatory concerns that forced them to shut down the project and refund investors, while Kowala (kUSD) has yet to come up with a live product — it will be added to Coinomi’s growing list of assets once that happens.
