Understanding Collateralized Stablecoin
A stablecoin is a digital asset built on the blockchain that aims to maintain a fixed price, typically $1.
To ensure its usability and credibility as a payment method, stablecoins are usually backed by collateral, including fiat cash, cryptocurrencies, or on-chain tokens.
This collateral is a reserve against which the stablecoin can be redeemed or swapped.
A “collateralized stablecoin” is a stablecoin fully or mostly backed by collateral held in reserve.
From Traditional Assets to Decentralized Tokens
The types of collateral used for these stablecoins can vary and may include cash, commercial papers, bond purchases, and more.
Sometimes, the collateral can be utilized for additional investment to enhance capital efficiency.
Stablecoins that rely entirely on-chain assets like cryptocurrencies as collateral, rather than traditional financial instruments, are often called “decentralized stablecoins.”
Overcoming Challenges in Collateralized Stablecoins
One challenge of collateralized stablecoins is the significant amount of capital required to establish trust and maintain stability.
These stablecoins often employ over-collateralization to absorb fluctuations in value.