What Are Crypto-collateralized Stablecoins and How They Work

What Are Crypto-collateralized Stablecoins and How They Work

Crypto-collateralized stablecoins are stablecoins backed by other cryptocurrencies to shield them from the high volatility of the reserve crypto. By ‘backing’ them, they act as collateral.

How Crypto-collateralized Stablecoins Work

Let’s say you deposit ether worth $10 and receive stablecoins amounting to $5; this ensures that the stablecoin is 200% collateralized. When Ether drops by $2, the stablecoin price will not drop because there is still $8 worth in ether collateral backing the stablecoin value. Unlike fiat-backed stablecoins, where the ratio is 1:1 in legal tender, these stablecoins have higher ratios, say 150%. It means that to receive $100 worth of DAI, you need $150 worth of ether. There are a couple of options when it comes to crypto-collateralized stablecoins, but we shall look at the most common ones.

Maker’s DAI ($DAI)

Dai is a crypto-collateralized ERC20 token backed by an excess amount of digital asset collateral (most commonly $ETH) through Maker Vaults. Dai utilizes smart contracts and a governance token, $MKR, to monitor price stability.

Dai has gained the most traction when it comes to general practice in the whole world. For example, users can earn up to $20 worth of Dai for answering questions about a Coinbase Earn project. 

Compared to crypto-collateralized stablecoins, sUSD excluded, they have been unable to show the basic framework and strategies needed to gain support from a vast part of the community.

Synthetix ($sUSD)

Earlier known as Havven, Synthetix is a crypto-collateralized network that enables synthetic assets to be created on the Ethereum blockchain. These assets are over-collateralized so that customers have enough liquidity to redeem collateral at face value. In addition to the $sUSD, Synthetix aims to provide stablecoins for other legal tenders, like the euro, yen, and the Korean won.

sUSD was created to appropriate DAI’s use cases. The stablecoin has more speed, the sUSD peg is better equipped to absorb massive issuance coming with traders generating leverage, and it has more natural buyers from Synthetix.

Reserve Tokens ($RSV)

$RSV is a token backed by both digital and fiat assets. Built initially on Ethereum, Reserve tokens are intended to be interoperable in the future across all blockchains. 

To scale the supply of Reserve tokens requires additional capital to maintain the target collateralization ratio when digital assets are chosen as collateral. The protocol sells newly minted Reserve Rights tokens to acquire additional collateral tokens. 

Like Maker Dai, the token of the Reserve uses the $RSR Governance token to decentralize monitor price stability.

Havven’s Nomin ($eUSD)

eUSD are ERC-20 tokens representing a new stablecoin generation. The stablecoin relies on Havven’s escrow technology leveraging the Havven tokens and the Ethereum mainnet. 

In addition, eUSD might be used in decentralized exchanges, along with stabilizations of other currencies. It can also assist the online working community as a very stable form of escrow.

Although eUSD offers several significant advantages, its complex design has many obstacles and has often faced criticism. It might lead to a lack of transparency on the part of the user.

Pros and Cons

Backing stablecoins with cryptocurrencies is loaded with advantages. First, users can ensure that it adheres to the transparent, trustless, and secure crypto world structure. Crypto-backed coins are considered transparent because they are recorded on the public blockchain creating accountability when transactions occur.

Crypto-backed coins are efficient in that converting from one crypto to another is fast due to their occurrence on the blockchain. The supply of stablecoins is also regulated on-chain by using smart contracts.

Despite the advantages, these coins are volatile and complex to some extent. To this, traders must use substantial collateral to ensure stability.

All in all, such stablecoins provide the much-needed comfort in offering a reliable exchange medium.

Wayne Jones

Wayne is an all-rounded cryptocurrency writer who has written for several publications in the fintech industry. Having graduated from the University of Essex Colchester, he developed a passion for blockchain technology and has been curious about how the blockchain can modify the traditional financial industry.