Cryptocurrencies paved the way for a new revolutionary type of money to spread throughout the world. This new medium of exchange is more open and accessible to most people compared to national currencies like the Peso or Dollar.
The crypto space is wild and prone to drastic price swings in short periods of time. Unfortunately, this volatility is impeding the adoption of these supposedly superior currencies. And thus, many companies have sought to create what many people in the industry call the “holy grail of crypto”: stablecoins.
These coins are simply cryptocurrencies whose values remain the same relative to most coins on the crypto market. All stablecoins are pegged to something; whether it’s another currency or an underlying asset; and in some cases, a particular value.
There are two types of stablecoins: collateralized and non-collateralized.
In this case, collateral is fundamentally an asset that is loaned in exchange for a particular stablecoin.
A fiat-collateralized stablecoin, such as UPHP (to be launched by UnionBank of the Philippines), is a stablecoin pegged to a national currency such as the Philippine Peso. Therefore, each UPHP has 1-1 ratio with 1 PHP and can be used to redeem cash.
This is the simplest form of stablecoins but it’s also centralized. Therefore, users have to trust the custodian issuing the coin. Furthermore, national currencies are still subject to inflation, and thus, this type of stablecoin is only as stable as the currency it is backed by.
A crypto-collateralized stablecoin is similar to its fiat-backed counterpart but instead of being backed by national currencies, it is backed by other cryptocurrencies. This type of stablecoin bypasses the high volatility of cryptocurrencies by over-collateralization; the value of the crypto collateral is kept above the circulating supply. This is to ensure that the system can cushion itself from massive price swings.
The most popular stablecoin of this kind is MakerDAO’s DAI.
This type of coin is also called an algorithmic stablecoin since its stability relies on an algorithm instead of an underlying asset. There are many variations of non-collateralized stablecoins but the idea is simple: you build a central bank-like system in a smart contract.
Basically, an algorithmic stablecoin either mints new coins when the demand is high or issue shares of future coins (debt) when the demand is low.
This type of stablecoin can absorb some amount of downward pressure for a time, but if it goes on for too long, traders will lose confidence that the shares of future coins will eventually payout, which would result in a crash. This is the least popular type of stablecoin.
This article is first published on BitPinas: [Guide] Stablecoins 101 | Introduction to Stablecoins