What is a Crypto-Collateralized Stablecoin?
A crypto-collateralized stablecoin is a type of digital currency designed to maintain a stable value by being backed by other cryptocurrencies as collateral. Unlike fiat-collateralized stablecoins, which are pegged to traditional currencies like the US dollar, crypto-collateralized stablecoins utilize cryptocurrency reserves to ensure price stability.
The process begins when users deposit cryptocurrency into a smart contract, which locks the asset as collateral. In exchange, the system issues stablecoins at a predetermined ratio. For example, a user may need to deposit $200 worth of Ether to receive $100 worth of a stablecoin. This over-collateralization helps mitigate the volatility associated with cryptocurrencies and ensures that the stablecoin maintains its peg.
If the value of the collateral drops significantly, the system may automatically liquidate the collateral to protect the stability of the stablecoin. Prominent examples of crypto-collateralized stablecoins include DAI, which is maintained by the MakerDAO protocol. These stablecoins are popular in the decentralized finance (DeFi) ecosystem, facilitating lending, borrowing, and trading without relying on traditional financial systems.
Overall, crypto-collateralized stablecoins represent an innovative financial instrument that promotes stability while leveraging the benefits of blockchain technology and decentralization.