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The Case for the Stablecoin

Here we discuss three fundamental models of stablecoins: Fiat/Commodity-collateralized, Cryptocurrency/Multi-Asset-collateralized, and Non-collateralized. Each model is described, highlighting its advantages and disadvantages, shedding light on their approaches to achieving stability in the volatile cryptocurrency market.

📄️ Fiat/Commodity-collateralized

These are cryptocurrencies that are practically fiat or commodity collateralized on a unit ratio of 1:1 or other specific ratios. It is in actual sense, a digital representation of a fiat currency or commodity. To participate, a user deposits fiat currency into a bank account, and the equivalent digital coin is issued. When users want to liquidate back into fiat money, their digital coins are destroyed, and fiat currency wired to them. This model requires a trusted custodian that warehouses the equivalent fiat currency or commodity, and grants access to appointed external auditors to keep the system true and transparent. Notable cryptocurrencies operating this model are Tether, TrueUSD and Digix Gold (with gold collateral instead of USD).

📄️ Crypto/Multi-Asset-collateralized

This model aims to ensure stability by collateralizing with cryptocurrency or multiple assets. How do you employ volatile cryptocurrency or multiple assets to back a stablecoin? This is usually through over-collateralization such that the stablecoins can absorb the volatility of the underlying cryptocurrency e.g. 1:2 or more ratio. If the price of the underlying instrument crashes beyond what the system can absorb, then the stablecoin is automatically liquidated into the underlying instrument, which then leaves the user exposed to market fluctuations. Notable cryptocurrencies using this model are BitUSD backed by BitShares, and MakerDao’s Dai. Vitalik Buterin has also proposed a collateralized debt obligation that issues stablecoins against loans of different tranches of seniority.

📄️ Non-collateralized

This model aims to ensure stability by adjusting supply. The first of this model for cryptocurrency, named seigniorage was proposed in 2014 by Robert Sams, where the monetary policy mandate is to trade at a specific USD price. When price is higher than that desired price, it suggests supply is too low, so the system mines more coins and auctions till price drops to required level. When the price is lower than the required level, the system buys up coins to return the price to the required level. If the reserve funds are lower than the amount of coins the system needs to buy, then seigniorage shares are issued that give the right to future profit earnings. Basis was intended to be an extension of this model and aimed to improve on seigniorage’s susceptibility to death spirals, where the price of shares is tied to recovery of demand for seigniorage coins. In the event that the coin’s demand doesn’t recover, the system risks collapse by issuing shares that will eventually be worthless.