May 15, 2022

What Are Stablecoins?

Stablecoins are a form of crypto-asset that are intended to allow users to enjoy the benefits of crypto and web3 without having to deal with the volatility commonly associated with other cryptos
By AJ Scolaro


Stablecoins aim to allow users to experience the accessibility, self-sovereignty, and decentralized trustless nature of blockchain while enjoying the price stability associated with stable currencies like the US dollar, or commodities like gold. There are different benefits and risks affiliated with each type of stablecoin that users should familiarize themselves with before indulging. Umee seeks to provide users with ample liquidity for all of the most trusted stablecoins in crypto on the chain(s) of their choice while conducting their yield seeking, leveraged trading, and/or staking strategies.


What Is a Stablecoin?

Stablecoins are a form of crypto-asset that are intended to allow users to enjoy the benefits of crypto and web3 without having to deal with the volatility commonly associated with other cryptos. Stablecoins achieve their price stability by being pegged to or backed by a commodity or fiat currency, or using algorithmic economics to regulate demand and supply. Many popular stablecoins are pegged to the US dollar, meaning that in theory they can always be redeemed by a user for $1 or $1 worth of another asset.

Stablecoins can be classified based on their stability mechanism. The most common types of stablecoins are fiat-backed, commodity-backed, crypto-backed, and algorithmic.


Fiat-Backed Stablecoins

Fiat-backed stablecoins aim to hold their pegs by maintaining reserves in fiat currencies. These stablecoins are commonly pegged to the US dollar due to its strength relative to other currencies.


Fiat-backed stablecoins are a popular choice among DeFi users because they have faith that they can redeem one fiat-backed stablecoin for one physical unit of the currency it represents at any time.


Centralized entities are needed to issue fiat-backed stablecoins and manage the reserves. This means that a fiat-backed stablecoin is only as good as the organization that issues it. These organizations may be targeted by authorities who wish to maintain full control over a currency, and/or be subject to banking regulations which other stablecoins may not be.




Commodity-backed stablecoins

Commodity-backed stablecoins are similar to fiat-backed stablecoins, except they are pegged to a commodity rather than a fiat currency, and thus issuers maintain reserves of commodities. Since commodities fluctuate in value, commodity-backed stablecoins also fluctuate.


Commodity-backed stablecoins allow users to gain exposure to key commodities while offering the same fungibility as other cryptos. Commodity-backed stablecoins allow users to transact with commodities in ways that are not possible through legacy markets.


Just like with fiat-backed stablecoins, centralized entities are typically needed to issue commodity-backed stablecoins and manage the reserves in order to ensure that one stablecoin can be redeemed for one unit of the commodity.




Crypto-backed stablecoins

Crypto-backed stablecoins are exactly what they sound like; stablecoins backed by other cryptocurrencies. Crypto-backed stablecoins typically require users to deposit crypto assets of greater value, and require users to be over-collateralized in order to maintain a $1 peg.


Crypto-backed stablecoins offer levels of decentralization that fiat-backed stablecoins cannot.


Crypto-backed stablecoins are only as good as the underlying collateral that backs them and the protocol that issues them. If a protocol is unable to ensure that crypto-backed stablecoins are properly over-collateralized at all times, the crypto-backed stablecoins issued by the protocol may lose their peg. 




Algorithmic stablecoins

Algorithmic stablecoins are unbacked or partially backed by other crypto-assets. They use algorithms to maintain their peg, which often involve the minting and burning of tokens based on the demand and value of the circulating stablecoin driven by economic incentives determined by their on-chain algorithms.


Algorithmic stablecoins are decentralized and may not require significant levels of over-collateralization to be issued.


Since algorithmic stablecoins are unbacked or partially backed, they are more susceptible to a de-peg than other types of stablecoins during market turmoil.




Umee’s Role

Umee functions as a cross-chain liquidity hub for cross-chain lending and borrowing, and stablecoins play a critical role for all Umee users. The vast majority of stablecoins are currently concentrated on Ethereum, and many others are spread throughout various crypto ecosystems. Cosmos DeFi users often have little or no choice regarding which stablecoin they earn, save, lend, trade against, borrow, or spend; they are at the mercy of the chain and protocol they’re interacting with.

Umee is a universal DeFi hub that is both chain and bridge agnostic. Umee users will be able to permissionlessly transfer their stablecoins of choice to and from the Umee network. Umee also has a set of risk control frameworks to assess the stablecoin assets listed on Umee, and make sure their individual risk profiles are thoroughly reflected in the asset parameters used as either lending and/or collateral assets. This will allow for better risk adjusted usability and capital efficiency, while greatly reducing the concentration of risk currently seen in DeFi.


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