Stablecoin.

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TLDR below. This is not financial advice.

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Introduction

In this crypto space, it is all about innovation. One of the key innovations today is the development of stablecoin mechanisms. The types of stablecoin mechanisms today are so varied that the 2017’s classification is not applicable. Today, stablecoin is more than just the classification of onchain collateral, offchain collateral and algorithmic stablecoin.

In addition, stablecoins have different objectives and reasons for existence. Because of these varying objectives, different types of stablecoins were born. Many of them have failed and only a few familiar faces remain. In this article, we share how to discuss the stablecoin toolkit to classify stablecoins.

2017 Stablecoin Mechanisms

In 2017 there was a very brilliant report that classified stablecoins into three kinds of mechanisms. It is not available anymore, but it was a popular article that everyone quoted.

1. On-chain stablecoins

These are coins like $DAI from MakerDAO where you take and keep on-chain assets like $ETH, $USDC, $YFI or $LINK. Then create stablecoins out of it. You take on-chain assets and use them as collaterals to mint $DAI.

2. Off-chain collateral

Off-chain collateral is where you give your money to someone and get the equivalent amount in crypto. Let’s say you give a 5 USD note to a company then that company gives you 5 crypto $USD. An example is $USDC which is managed by Coinbase — you send USD to Coinbase and it gives you crypto USD. Every 1 $USDC is backed by 1 USD in the Coinbase bank.

3. Algo stablecoins

Algo stablecoins can be classified as different kinds of rebasing mechanisms. Examples are $UST (TerraUSD on the $LUNA network), or Amperforth, as well as mechanisms like Empty Set Dollar and Dynamic Set Dollar. $FEI is also considered algo stablecoin. We did the recent analysis here.

2021 Stablecoin Mechanism

Today, we have a better way to classify these mechanisms. Shoutout to Amani Moin, Emin Gün Sirer and Kevin Sekniqi for their great research paper.

Reserves

Most of these stablecoins are backed by reserves. Just like after World War II when the world economy was recovering, and a lot of currencies were volatile. Money was backed by gold and every central bank had gold in the bank. When they printed currency like 1 USD, it was worth that amount of gold in the reserve. This means that the stablecoin can be redeemed for the underlying reserve.

The reserves then were gold but today it could be a lot of things like on-chain collaterals or off-chain collaterals. It could be like a MakerDAO where you have a lot of different kinds of currencies like $ETH, $YFI or $AAVE. Or it could be off-chain collaterals like gold, US dollars, Japanese yen, etc. Reserves are used to create mechanisms to determine stablecoins with low volatility.

Dual Token

When we talk about stablecoins, we are talking about a coin with low volatility or a coin that does not move much. But the truth is that a lot of things actually do still move and there is a lot of volatility in the space.

The dual token model has one token that is stable while the other token absorbs the volatility. When prices go up or down the secondary token absorbs the volatility. The secondary token could do a lot of other things but the main purpose is to absorb volatility so that it does not impact the stablecoin.

Algo stablecoins

An algo stablecoin is about creating a stablecoin defined by math. The math changes according to different market changes, to allow the stablecoin to remain at its peg value (e.g., $1).

You can change the math if you want (e.g., multi-sig governance) or if the governance votes for it (e.g., DAO). Algo stablecoins come in many different types. You have a rebasing model, a bond-like model, and a debt-like model.

Mixed

A mixed mechanism is a combination of two or a combination of all of the mechanisms; these mechanisms need not exist alone. In stablecoins, one mechanism is not the end and you can mix them up because they serve different kinds of purposes and have a different kind of volatility. You can hedge against volatility in a variety of ways.

Thus, we have four mechanisms in 2021.

Types of Peg

When we talk about stablecoins people usually think that it is just crypto USD, but that is not true because a stablecoin is stable relative to something which is relative to the Peg.

A stablecoin peg is not limited to just U.S dollars — a stablecoin is stable relative to whatever it is pegged to.

Fiat

In the U.S denominated currencies, you have $USDT, $USDC, $alUSD, $DAI and a lot of different kinds of mechanisms coming out to create the crypto version of USD. But the world is not just about USD. There are other currencies available too like SGD or the Singapore dollar where you have $XSGD. Stablecoins are being pegged to different kinds of fiat currencies like the Swiss Franc or the Japanese Yen or the Euro because then it makes the transaction a lot easier within the ecosystem.

Commodities

You can also have a commodity as a peg. For example, you could have stablecoin pegged to gold. One stablecoin would be equivalent to one ounce of pure gold. It is a stablecoin because it is stable relative to the underlying asset, which is your commodity.

Another example is wBTC. Bitcoin is the underlying commodity. wBTC uses BTC as collateral to create a wrapped version that is ERC20 compatible.

Combination

You can also have a combination. For example, some protocols like MahaDAO are looking at combining fiat and commodities into a basket that they create themselves and have a stablecoin pegged to that basket. This is fairer as it is not dependent on one country’s currency like the US.

Index

An index is something that is a bit more defined. It could be a basket of goods or it could be the CPI. When we talk about Ampleforth, its value is not pegged to just the USD in general, but to the CPI of USD in 2019.

Learning point: CPI is the consumer price index which is an index released to show the prices of goods at a particular point in time.

When we talk about peg, it is not just about U.S dollars, and it is not just about the U.S dollar right now. It could be the U.S dollar of 2019 with an index, or gold with commodities, or a combination of different types of assets.

Collateral

Collateral Amount

When we look at the collateral amount we have four main classifications:

Full: This is 100% pegged. Let’s take an example of $USDC which is pegged 100% so 100 US dollars in Coinbase bank can be used to create 100 $USDC.
Partial: This could be where only 50% is pegged by a reserve and the other 50% is not.
None: There could be no Pegs at all. It could be purely dual currencies or purely Algo stablecoins where the coin is not backed by anything.
Over-pegged: Here the collateral is more than 100%. We see a lot of cases like this with usually more than 150%, but we also see Liquity ($LQTY) exploring 110%. You have different kinds of stablecoin mechanisms and different protocols experimenting with over-collateralisation, like Alchemix ($ALCX) which is 200% over-pegged. These coins are over-pegged for a specific reason because the mechanism, structure and objectives of the stablecoin have a secondary purpose.

Collateral Type

We have different reserves and in these we have different kinds of things. You can think of a reserve being like a safety deposit box in the bank where you can put all kinds of things:

It could be fiat like USD, SGD, etc.
It could be commodities like gold, silver, platinum, gemstones, cereal, rice, etc.
It could be a combination of both.
It could be crypto as well so a combination of all of them.
It could also be nothing so that it is purely Algo stablecoins.

Stablecoin Creation Toolkit

In an ecosystem we are trying to allow for transaction, coordination and cooperation between different types of agents in the system. Stablecoins are good because their prices are not so volatile so it is easier to transact.

How do we use the different tools available to create the right kind of stablecoins to achieve our objectives?

It is okay to experiment with different kinds of stablecoins because different stablecoins can have different objectives. For example, when we talk about Alchemix (with 200% over-collateralisation) they are helping you to reinvest your assets, so that you get returns today. This is similar to getting a loan in advance while the capital is earning the returns. This makes the mechanism more capital efficient.

You can have different kinds of mechanisms and different kinds of collateral amounts because there is no right answer and we are still experimenting. It really depends on the kind of objectives that you are looking at and the kind of outcomes you are wanting to create.

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TLDR:

Although, stablecoin is no stranger to many people, it is still developing and improving the existing advantages — from creating the first stablecoins to having them automatically adjust to the market. These adaptations are something to be proud of, but is every market phase the same?

As we can see, the Stablecoin market is a “play ground” for projects that fully answer the three questions above. In the future, we will see a variety of complex stablecoins, including many tools that aid in securing the anchor. This is a topic that will be discussed further in the future.

Ps: Order the textbook “Economics and Math of Token Engineering and DeFi” today!