Opinion: Why are decentralized stablecoins so important?

Before we delve into the topic of decentralized stablecoins, let's review what stablecoins are. So, what exactly is a stablecoin? It is a type of cryptocurrency. But unlike most cryptocurrencies, the value of a stablecoin is pegged to the legal currency of one or more countries. Not only national currencies, but some stablecoins are also pegged to physical assets. Therefore, a stablecoin is a cryptocurrency whose value is backed by one or more financial assets.

Types of Stablecoins

The categories of stablecoins are based on the assets that back the value of the stablecoin. There are four types of stablecoins:

1. Fiat-collateralized stablecoins

2. Commodity-collateralized stablecoins

3. Crypto-asset collateralized stablecoins

4. Algorithmic Stablecoins

• Fiat-collateralized stablecoins

When it comes to the most common types of stablecoins, fiat-collateralized stablecoins dominate the stablecoin space. The value of these stablecoins is backed by one or more fiat currencies. The most popular fiat currencies used here are the US dollar, the euro, and the British pound.

Each fiat-collateralized stablecoin is pegged to the corresponding fiat currency at a 1:1 ratio. For every stablecoin in circulation, an equal amount of fiat currency is required to back it. The amount backing the fiat-collateralized stablecoin is usually held in a bank account.

Let's say, a person has 100 USD-backed stablecoins. Now, he wants to redeem the stablecoins with an equal amount of USD. So, the company that manages the stablecoins will remit 100 USD to his bank account through their reserves. So, what happens when this person redeems 100 USD-backed stablecoins for fiat USD? The answer is that these 100 USD-backed stablecoins are removed from circulation.

• Commodity-collateralized stablecoins

Commodity-backed stablecoins are not backed by currencies, but by assets such as precious metals. Gold has proven to be the most common commodity in the commodity-backed stablecoin space. Other assets such as real estate, other precious metals, and oil are also used as collateral to create commodity-backed stablecoins.

The advantage of holding a commodity-backed stablecoin is that its holder actually owns a share of something with real value - unlike most cryptocurrencies. Holders of such stablecoins can also benefit if the price of the collateralized asset increases in the future.

• Crypto-asset collateralized stablecoins

Crypto-collateralized stablecoins are backed by major cryptocurrencies such as Bitcoin and Ethereum. These types of stablecoins are more decentralized than those backed by currencies and various commodities. Overcollateralization is a major feature of crypto-collateralized stablecoins. Why? Because it plays a role in hedging against price volatility risks and helps crypto-collateralized stablecoins absorb price fluctuations.

For example, to get $100 worth of crypto-collateralized stablecoins, you have to deposit $150 worth of ETH. You can see that the collateralization ratio here is 150%. Now, even if the price of the underlying asset drops, the stablecoin can withstand the depreciation of the price. But if the price drops low enough, then the system will automatically liquidate the stablecoin.

Do you want trustless, secure, and transparent stablecoins? Crypto-collateralized stablecoins are your best bet. Because they are more decentralized than currency and commodity-backed stablecoins. There is no entity calling the shots when it comes to crypto-collateralized stablecoin funds. But they still offer good risk diversification because they are usually backed by multiple cryptocurrencies.

If you choose these types of stablecoins, you will also benefit from their higher liquidity. These stablecoins can also be converted into the underlying crypto assets at a cheap price, but at the same time they are also one of the most complex stablecoins. Therefore, we have not seen the same traction as fiat-backed cryptocurrencies so far.

Do you know which crypto-asset collateralized stablecoin is the most popular? You must have heard of it - Dai from MakerDAO. It is a stablecoin whose value is backed by multiple crypto assets such as ETH. The face value of Dai is pegged to the US dollar, and the collateralized ETH is held in the form of a smart contract.

• Algorithmic Stablecoins

As their name suggests, there is no asset backing the value of uncollateralized stablecoins. This may cause many people to wonder what stablecoins are. Take the US dollar for example - in the past, every dollar was backed by gold. But things have changed, and in recent decades the dollar has not had anything to back it up. Is the dollar starting to become unstable? Of course not! Algorithmic stablecoins use the same concept.

The seignorage model is at the heart of how the supply of algorithmic stablecoins works. The principle is to control the supply of these stablecoins by means of algorithmic governance. If the demand for algorithmic stablecoins increases, new coins are created. This leads to a reduction in the price, and soon the price returns to normal levels. The opposite happens when the price of an algorithmic stablecoin becomes too low. You can see that market supply and demand keep the prices of these stablecoins stable.

When it comes to decentralized stablecoins on the market, algorithmic stablecoins account for the majority. Even if fiat currencies such as the dollar or euro collapse along with the crypto market, algorithmic stablecoins will remain strong and survive the collapse. But there is a big problem with algorithmic stablecoins - once they collapse, stablecoin holders will not be able to liquidate. This is because these stablecoins do not involve any collateral.

So, what type of stablecoins are decentralized? Crypto-collateralized and uncollateralized stablecoins are truly decentralized stablecoins. Let’s take a look at Dai, as it is currently the most popular decentralized stablecoin in the crypto market.

A quick guide to Dai, the most popular decentralized stablecoin

DAI is a crypto-asset collateralized stablecoin as mentioned above, it is an ERC20 token. Dai is the core part of the MakerDAO lending platform. All MakerDAO users need Dai to borrow and repay. At the same time, you can easily transfer Dai between Ethereum wallets.

Smart contracts are automatically executed to control the price of Dai. When the price of Dai rises above $1, Maker tokens (MKR) are burned. If the price of Dai drops significantly against a dollar, more DAI tokens are created to stabilize the price.

There is actually no need to rely on anyone to keep DAI stable - you must be wondering, why is this the case? The reason is that all the work is done by MakerDAO's algorithm, which means that it is the algorithm that manages the price of DAI.

The thing about DAI is that DAI is only generated when a person takes out a loan from the MakerDAO platform. Once the loan is paid off, the DAI is destroyed. So, you can get DAI by taking out a loan from MakerDAO's Oasis platform. This is the most direct way to get DAI. Another way is to trade DAI on MakerDAO's Oasis platform. Similarly, you can trade DAI on any centralized exchange.

Why are decentralized stablecoins so important?

When it comes to decentralized stablecoins, their operations and funds are very transparent, so we can be assured of the entire operation process. Because all the details of their funds are on the public blockchain, everyone can verify it.

Stablecoins play a very important role in the crypto trading market. Traders and crypto enthusiasts who are afraid of the volatility of cryptocurrencies can still participate in the crypto industry through stablecoins. They can hold stablecoins because they are not as volatile as other cryptocurrencies.

in conclusion

As of now, fiat-collateralized stablecoins have the largest market share in the cryptocurrency market. But decentralized stablecoins are catching up with currency-collateralized stablecoins. We expect decentralized stablecoins to continue to maintain their growth momentum. With the increasing popularity of DeFi, it is only a matter of time before decentralized stablecoins surpass fiat-collateralized stablecoins in the market.