COLLATERALIZED STABLECOINS VS ALGORITHMIC STABLECOINS

14/7/2022

COLLATERALIZED STABLECOINS VS ALGORITHMIC STABLECOINS

There are two types of stablecoins categories,which is collateralized stablecoins and algorithmic stablecoins.The collateralized stable coins have two different type which is fiat collateralized or crypto collateralized.Fiat collateralized stablecoins are backed by sovereign currency such as the pound or the US dollar.It means that to issue a certain number of tokens of a given cryptocurrency,the issuer must offer dollar reserves worth the same amount as collateral.Other forms of collateral can include precious metals like gold or silver as well as commodities like crude oil,but most fiat-collateralized stablecoins have reserves of U.S dollar.Tether (USDT) and BinanceUSD (BUSD) are popular stablecoins backed by U.S. dollar reserves and denominated at parity to the dollar. 

Crypto-collateralized stablecoins are a key element of the DeFi ecosystem.These stablecoins over-collateralize an existing digital asset to allow for the dynamic maintenance of a consistent market price fluctuations caused by the underlying collateral.To receive a crypto-collateralized stablecoin,you must lock your collateral tokens in a smart contract.The collateral is retrievable at a later date by paying stablecoins back into the smart contract,thus liquidating the position.For example, MakerDAO's Dai (DAI) stablecoin is pegged to the U.S. dollar but backed by Ethereum (ETH) and other cryptocurrencies worth 150% of the DAI stablecoin in circulation.

Algorithmic stablecoins do not use fiat or any type of cash reserves as collateral.Algorithmic stablecoins are pegged to the value systems of other assets via smart contracts that increase or decrease supply based on current market values.When an algorithmic stablecoin trades above its peg, coins are minted,lowering its value;when it trades less than its pegs, coins are burned, raising the price.Stablecoins like Terra (UST) and Tron (USDD) are algorithmic stablecoins.The most important factor to consider when assessing stablecoins is how well they keep their pegs.To respond to changes in supply and demand, collateralized stablecoins involve liquid assets that can be traded quickly.Algorithmic stablecoins never use collateral,rather depend on smart contracts to provide theoretically infinite liquidity.

While algorithmic stablecoins sound great in theory,they still have a long way to go before they are considered a stable store of value.At the time of publication,no algorithmic stablecoin has fully achieved stable pegs.Most use cases are now for speculative traders.Just like other stablecoins and cryptocurrencies,regulation will be important in algorithmic stablecoins.Compared to other cryptocurrencies,stablecoins pose a huge threat to the government's fiat currency system.Algorithmic stablecoins are censorship-resistant and pose a greater theoretical than non-algorithmic stablecoins.