What is Collateralized Stablecoin?

As we have heard, a stablecoin is a digital asset built on a blockchain that is designed to keep its value at a fixed price, usually $1. This aims to maintain that it can still function properly and legitimately as a payment method. As a payment method, they must have backing in the form of cash, cryptocurrencies, or on-chain tokens that can be swapped. This backing is referred to as collateral.

Collateralized stablecoin is a type of stablecoin that is fully or almost fully backed by collateral held in a reserve. The collateral provided on these stablecoins may vary. These include cash, securities, purchase of bonds, and others. Stablecoins that fully tie their collateral to on-chain assets such as crypto rather than traditional bonds/financial papers are often referred to as “decentralized stablecoins”.

Three Different Types of Collateralized Stablecoins

1. Fiat-collateralized stablecoin

A fiat-backed stablecoin has a reserve of fiat currency or a currency such as the US dollar, as collateral to maintain its value. Other popular collateral can be precious metals such as gold and silver. However, most fiat-backed stablecoins usually have US dollar reserves.

This US dollar reserve is managed by an independent custodian who is audited regularly. For example, Tether (USDT) and TrueUSD (TUSD) are two popular stablecoins that are backed by the US dollar and are paired at a 1:1 ratio.

2. Crypto-collateralized stablecoin

Stablecoins can also be backed by cryptocurrencies which means that these assets are backed by other cryptocurrencies and not by fiat currencies. Given that the crypto asset reserves that support these stablecoins are also vulnerable to high volatility, these stablecoins are over-collateralized. In other words, the value of the crypto assets held in the reserve exceeds the value of the issued stablecoins.

For example, to protect against the threat of a 50% drop in the price of a stablecoin, the reserve of crypto assets can be up to twice the value of the issued stablecoin. One of the most popular examples of this category of crypto-collateralized stablecoins is MakerDAO’s DAI (DAI) stablecoin. Where it is pegged to the US dollar. This asset is backed by Ethereum and other crypto assets which are worth 150% of the total supply of DAI stablecoins.

3. Commodity-collateralized stablecoin

The next type of stablecoin is commodity-collateralized stablecoin, which is a stablecoin whose price is set according to the price of a commodity, or other exchangeable asset. Commodities used are precious metals such as gold or silver, but some use properties. Like commodities in the real world, it is possible that the value of this type of stablecoin can go up or down over time.

Stablecoins in this category include PAX Gold (PAXG), Tether Gold (XAUT), and Digix Gold (DGX). Where the price follows the price movement of the precious metal gold. There is also Secure Coin (SRC) whose value is guaranteed by a property portfolio in Switzerland.