Stablecoins: Not All Are Created Equally
Disclaimer: Although we use the terminology “stablecoin,” we don’t claim that these assets will always hold their peg. We call SIKKA a stable asset, reflecting that it’s over-collateralization price stability has a few days lag time.
Stablecoins have been around for a while, and they have grown in popularity tremendously in the past couple of years. The interest in stablecoins is not restricted to the crypto community. Traditional market investors and institutions are investigating the potential of leveraging stablecoins. As a result, the need for a thorough knowledge of the various stablecoin kinds has recently skyrocketed.
Stablecoins are simply cryptocurrencies whose value is tied to a stable asset, such as precious metals or fiat currencies like the US dollar. The various stablecoin categories are essentially reflective of the assets that support them. A thorough study of the many forms of stablecoins might assist you in developing prospective foundation-level knowledge on stablecoins.
Why Should I Be Concerned About Stablecoin Variants?
The curiosity regarding the various sorts of stablecoins is also related to the severe market downturns. The recent high levels of volatility in the crypto realm have contributed to increased demand for stablecoins. The biggest stablecoin, Tether or USDT, now has a market value of about $82 billion. USD Coin, or USDC, is the second-largest stablecoin in the crypto economy, with about $48 billion. As a result, the interest in the different types of stablecoin architectures has been on the rise, especially after the de-pegging of the algorithmic stablecoin UST.
Stablecoin Variants
Stablecoins may be identified by the collateral arrangements that support them. There are four main kinds of collateral structures for stablecoins, which serve as the foundation for the various forms of stablecoins. Stable assets are classified into the following categories based on their underlying collateral structure:
1. Stablecoins with Fiat collateral
Fiat-collateralized stablecoins are the most common kind of stablecoin you’ll come across. They are backed by a fiat currency such as the Euro, GBP, or US Dollar. Fiat-collateralized stablecoins are the most basic stablecoin, having a 1:1 ration backing. The 1:1 ratio suggests that one stablecoin is equivalent to one unit of money, such as one dollar or one Euro.
As a result, every fiat-backed stablecoins is backed by actual fiat cash in a bank account. Users may redeem their coins by requesting that the company in charge of the stablecoin transfer the equivalent amount of fiat cash from their reserve to the user’s bank account. Simultaneously, the corresponding number of stablecoins are removed from circulation or destroyed.
The essential benefit for novices to better comprehend cryptocurrency is simplicity. Fiat-backed stablecoins are among the simplest stablecoin kinds owing to their structural benefit. A fiat currency value stability guarantees that the value of stablecoins fluctuates very little. As a result, fiat-backed stablecoins might play a significant role in fostering the widespread use of stablecoins.
2. Commodity-backed Stablecoins
Commodity-backed stablecoins, as the name suggests, are backed by various sorts of tradable assets such as precious metals. Gold is the most often utilized commodity as security for commodity-backed stablecoins.
In addition, many additional stablecoins are backed by assets other than gold, such as real estate, oil, and precious metals. Owners of commodity-collateralized stablecoins essentially hold a genuine item with actual value. This gives it a significant edge over the rest of the cryptocurrencies.
Commodities, in general, have the potential to appreciate in value over time. Consequently, such stablecoins tend to provide higher incentives to those who store and use commodity-backed stablecoins. Commodity-collateralized stablecoins, on the other hand, enable investors from all around the world to purchase gold and other commodities.
Historically, commodities were exclusively available to the financially elite. However, commodity-backed stablecoins provide new investing alternatives for the common individual, regardless of net worth or location.
PAXGold, or PAXG, is the most popular example of a commodity-backed stablecoin. It is essentially an ERC-20 token created on the Ethereum network and backed by actual gold. PAXGold is the ideal example of a commodity-backed stablecoin, with one PAXG pegged to one gram of gold held in a Brink’s vault.
3. Cryptocurrency-backed Stablecoins
The idea of cryptocurrencies supporting stablecoins seems strange at first. What about cryptocurrency volatility? How can stablecoins backed by cryptocurrencies be expected to be stable? In fact, crypto-collateralized stablecoins provide more decentralization than fiat-collateralized stablecoins. Furthermore, stablecoins are often over-collateralized in order to absorb price volatility as collateral.
Assume you must invest about $1000 in Ether in order to receive $500 in stablecoins. As a result, you can see that stablecoins are 200 percent collateralized, signaling the likelihood of a 25% price decline. After the price decline, you’d still have $500 worth of stablecoins, backed up by $750 worth of Ether. If the price of cryptocurrency collateral falls significantly, stablecoins will be liquidated immediately.
The most important feature of this entry in the stablecoin category is decentralization. The advantage of decentralization is that a single body does not control your finances. Stablecoins backed by cryptocurrency might help processes become more trustless by improving security and transparency.
Furthermore, many crypto-backed stablecoins have numerous cryptocurrencies backing them to ensure efficient risk allocation. Additionally, crypto-backed stablecoins benefit from increased liquidity.
4. Algorithmic or Non-Collateralized Stablecoins
The fourth stablecoin category addition would be non-collateralized or algorithmic stablecoins. Non-collateralized or algorithmic stablecoins lack assets or collateral to back them up. Non-collateralized or algorithmic stablecoins use an algorithm to manage the supply of stablecoins. In the case of very low coin trading, coins on the market are acquired in order to reduce the circulating supply. As demand grows, additional stablecoins will be issued to bring the price back to normal.
Essentially, algorithmic stablecoins might provide stability based on market supply and demand. It is also worth noting that algorithmic stablecoins have the maximum amount of decentralization and independence. Such algorithmic versions of blockchain, on the other hand, rely on continuous expansion to ensure success. You should be aware that there is no collateral associated with algorithmic stablecoins for liquidity, and everyone stands to lose money in the event of a crisis.
The nest example of this risk is the recent de-pegging of the popular algorithmic stablecoin UST. Its value dropped from $1 to $0.3 overnight, causing significant financial damage to its holders and reflecting on the entire crypto market.
In conclusion
Stable assets now operate under four separate models, each with its own collateral structure. Stable assets are classified according to their collateral, including fiat-backed, commodity-backed, crypto-backed, and non-collateralized stablecoins. Each stablecoin variety has a distinct feature: the collateral used to support the stablecoin.
Therefore, the architecture of each stablecoin should be evaluated based on the user’s intentions. For example, crypto-backed stablecoins provide more liquidity, but fiat-backed stablecoins are simpler for novices to comprehend and utilize. They are ideal for those who want to store value or make payments within the crypto ecosystem without worrying about volatility. However, for sustainability and versatility, over-collateralized crypto-backed stablecoins such as MakerDAO (DAI) and the upcoming Sikka protocol USD stable asset are ideal for crypto players who want to use crypto in DeFi in a sustainable and secure way.
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