Crypto backed stablecoins are a variety of stablecoins which collateralize crypto assets using an electronic vault system. Most commonly ‘Ethereum’ is the collateral used.
Commonly used ones include DAI (DAI) which is pegged to USD (USD) but backed by Ethereum (ETH).
These stablecoins are inherently more decentralised than their fiat-backed counterparts but suffer in other ways.
The most used crypto-backed stablecoin is DAI (DAI), the native stablecoin of one of DeFi’s forefathers and oldest protocols, MakerDAO. These types of stablecoins can track the value of a fiat currency through balancing mechanisms on the blockchain, which use the stablecoins’ backing to ensure price stability.
Crypto-backed stablecoins operate with an ‘I.O.U’ concept, more commonly known as a ‘security pledge’ to account for the volatility of the collateral. If Ethereum moves up by 20%, this needs to be accounted for via the security pledge to help maintain the 1:1 peg. If the peg is not able to be held, arbitrage opportunities may occur.
Pros:
- High level of decentralisation
- Higher level of transparency as collateral is locked in smart contracts which are visible on blockchain explorers
- Being blockchain based, the issuance and redemption of transactions are settled faster
- Higher liquidity due to the backing asset collateral
Cons
- Much more complex compared to fiat-backed stablecoins for a consumer to understand and use
- The collateral performance dictates the stablecoin’s performance and is subject to high spikes and dips
For more information, visit our complete guide to stablecoins.
