What is a Stablecoin And What Does it Do

• By Yanhan
• 25-07-2022
• Technology

At present, many people clearly know that blockchain technology and cryptocurrency will disrupt many industries, but there are still some factors hindering the adoption of blockchain technology, such as the following factors

1. Volatility

Market instability due to high speculation and high price changes

2. Regulation.

The uncertainty that many governments have yet to take a position has prevented many companies from building their own systems

3. User experience

After all, using cryptocurrencies is not convenient, especially for most people

The problem of volatility is the most difficult to solve, and stablecoins were created to solve this problem

What are stablecoins?

Stablecoins are crypto assets that maintain a stable value against a target price. It is 1:1 anchored to an asset in the real world with a stable value in the chain (e.g., USD, RMB, etc.) and retains the same value. As a medium of exchange, stablecoins solve the problem of circulation between digital and fiat currencies, and are one of the key elements of the crypto industry.

What are the types of stablecoins?

At present, there are three main types of stablesoins in the market, namely, stablesoins mortgaged by legal currency, stablesoins mortgaged by cryptocurrency, and stablesoins without low bet.

1. Legal tender mortgage mode. Deposit 1:1 in the bank with legal tender as collateral to ensure the stability of digital assets.
2. Cryptocurrency mortgage model. Cryptocurrency as excess collateral, further associated with stablecoin.
3. Unsecured mechanism. There is no collateral, only by the algorithm mechanism such as coin burning to anchor.

Legal tender mortgage

The most widely used stablecoin in the market is the stablecoin with legal tender as collateral. The most typical case is USDT issued by Tether Company, which is called Teda coin in Chinese. Each USDT issued is pegged to a dollar for dollar, and the corresponding dollar amount is stored at Tether's headquarters. The value of The Teda dollar, which is backed by dollars, is not subject to any fluctuation risk.

The limitation of this kind of staboin is that it is centralized, opaque, and without the guarantee of storing funds, it is difficult for users to determine whether the issuer has really deposited the corresponding assets under the chain.

Crypto collateral

In this model, the collateral backing a stable currency is itself a decentralized crypto asset. This method allows users to create stable currency by locking in collateral that exceeds the total amount of stable currency.

A prime example of cryptocurrency as excess collateral is DAI, a stablecoin issued by MakerDAO, a decentralized autonomous organization on Ethereum. Users who want to acquire DAI coins need to deposit ETH on the Maker platform controlled by the Ethereum smart contract and lock ETH as collateral, and then generate new DAI coins in the form of debt to enter the market. MakerDAO requires overcollateral, meaning that the value of the collateral must be greater than the value of DAI coins that can be lent to protect against fluctuations in ETH prices.

And MakerDAO has a unique mechanism for maintaining DAI's one-to-one anchor against the DOLLAR

When the value of DAI falls below $1, smart contracts ratchet up the excess mortgage rate, making IT expensive to generate DAI from CDP. The user gets fewer DAI for the same value of the asset, and the arbitrageur gains by redeemable the asset that the user has locked up in the first place with fewer DAI. When DAI is worth more than $1, smart contracts reduce excess collateral rates and increase the return on capital to own DAI, which arbitrageurs can profit from and increase the demand for DAI generation by users

 No mortgage

The stablesoin which legal tender is used as collateral has gradually been accepted and widely adopted. The vision of original coinage in the blockchain industry is also developing, and algorithm stablesoin comes into being. The "algorithmic" mechanism in algorithmic stabbcoin is usually echoed with the "arbitrage" mechanism. Issuing institutions do not set up any off-chain or on-chain reserve funds, and do not need collateral. They only use mechanisms such as coin burning to anchor stabbcoin and US dollar.

Its limitation is that stability is usually maintained by centralized mechanisms

Stablecoin

Staboins have been described as the "Holy Grail" of cryptocurrencies. They dramatically lower the barrier to entry into the crypto market, and staboins have many uses, serving as a bridge between the real and crypto worlds. Stablesoin acts as a measure of value and serves as a hedge in the process of market decline.

Stablesoins have played an enormous role in the introduction of cryptocurrencies into major projects, but stablesoins are not necessarily stable.