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Beware: Not all stable coins are created equal - Part two

by Joshua Benton, Editor, The South Africa Investor, 01 October 2018
Beware: Not all stable coins are created equal - Part two
Last week, I explained a “new” type of cryptocurrency that's making headlines - stable coins.

More specifically, I delved into the first type of stable coin currently available right now called fiat-collateralised stable coins.

These are simply coins backed by real currencies like dollars and gold to bring stability to the volatile crypto market.

Today, I'm going to share the next type of stable coin, which in fact, solves one of fiat-collateralised stable coin's biggest problems - centralisation.


They’re called…
 
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Crypto-collateralised stable coins: More decentralized and more liquid

Instead of being backed by gold or dollars, crypto-collateralized stable coins are backed by reserves of another cryptocurrency.

Not only does this help achieve price stability, it also addresses the centralisation aspect of fiat-collateralised coins.

But now you may be thinking, being backed by a normal cryptocurrency can be unstable as they’re usually volatile?

While this is true, to counteract this, crypto-collateralised coins are often over-collateralised to absorb price fluctuations with the excess reserves.

The concept works like this…

To get one $1 stable coin, you deposit $2 worth of the collateral coin. That means, the stable coin is 200% collateralised, which creates a lot of leeway should the collateral coin drop in value.

So what crypto-collateralised stable coins are available right now?

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Two stable coins backed by ordinary cryptocurrencies
 

#1: BitShares – They were the first cryptocurrency to use this form of collateralisation. They use their native network currency (bitshares) as collateral to create market pegged assets such as BitUSD, BitCNY and BitGold.

Also, these assets can then be traded like derivatives to effectively increase the collateral. Today, BitShares is quite popular with a market cap of over $300 million.

#2: DAI – Developed by MakerDAO. Dai is pegged to USD but collateralised by well-known crypto Ethereum.

This means, users could generate the stable coin by locking up lots of ethereum in a smart contract. And if a user wants to access their collateral, they simply have to pay back the DAI debt, without relying on a third party institution. Alternatively, the reserves will be sold automatically if the collateral dips below a specified threshold.

MakerDAO and DAI have been criticized for being highly complex and untested model. This is mainly why DAI’s acceptance as a stablecoin has been quite slow – evident as it only has a market cap of $55million.
 
 
 
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The downfalls of crypto-collateralised stable coins
 
Although, crypto collateralised stable coins are more decentralized and more liquid than their fiat collateralised, they also have their downfalls…

Firstly, the reliance on a cryptocurrency as collateral makes them less stable and also requires huge amounts of capital to absorb inevitable price fluctuations.

Secondly, they rely on very complex mechanisms to ensure stability which is likely to scare off many potential users. But as with all problems facing the crypto world, they’re working to solve these problems one by one.

See you next week where I’ll reveal the last type of stable coin. And if they’re worth your money.

See you next week where I’ll reveal the next type of stable coin.

Joshua Benton,
Managing Editor, The South African Investor
 
 
P.S. There are still a few spots left for readers unlock the FREE Crypto Master Series – worth R5,000. But you better hurry, as this deal won’t be available for too long.
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Beware: Not all stable coins are created equal - Part two
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