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A stablecoin is a cryptocurrency designed to minimize price volatility.
Fiat-backed stablecoins, crypto-backed stablecoin, and algorithmic stablecoin are some example of the different kind of stablecoin that is still being issued
- A fiat-backed stablecoin can be defined as a cryptocurrency that is collateralized 1:1 with a specific fiat currency. Issuance of this type of stablecoin will require depositing fiat currency into a specific institution where the value of the stablecoin will be corresponding to the deposit amount.
- A crypto-backed stablecoin is a stablecoin that entrusts another cryptocurrency such as Ethereum to a smart contract and borrows it according to the collateralized loan ratio of the protocol.
- Algorithmic stablecoins regulate supply according to a predetermined mathematical algorithm when their price is higher or lower than the price of referring cryptocurrency.
The cryptocurrencies representing each stablecoin type are as follows.
Tether: A stablecoin secured by fiat currency issued by the Tether institution as collateral.
Tether has a straightforward issuance process. When fiat currency is deposited into a Tether institution, Tether is issued. In addition, when a user returns Tether, it is burned, and the dollar equivalent to the value of the burned Tether is redeemed. Tether is on several chains, but transactions are mainly carried out on the Ethereum main chain. This process is similar to the bank mechanism, and where the depositing and lending money system is the same.
Dai: A crypto-backed stablecoin issued by MakerDAO
When cryptocurrency is deposited into MakerDAO, stablecoin Dai will be issued. Various types of cryptocurrencies can be pledged as collateral, but the primary transaction will be Ethereum. As a specific issuance method of DAI, depositing collateral in MakerDAO creates a debt position called CDP. CDP users create $1 pegged Dai with CDP collateral. Dai maintains its price at $1 follows the supply and demand principle in economics.
Terra: Stablecoin with guaranteed stability due to staking token LUNA
The Terra ecosystem consists of LUNA, a cryptocurrency with variable value, and stablecoins with immutable values (UST, KRT, and more). The stability of the stablecoin is designed and guaranteed by Luna, which ironically changes in value. Luna uses a validator node, and through this validation node, Luna is burned, and Terra’s stablecoins will be issued. Conversely, it is also possible to issue Luna by burning the stablecoins of the Terra ecosystem.
Many new projects are being launched one after another under the influence of Terra, which seems to be one of the most successful projects to date. There is no way of telling what kind of impact this will have in the future, but the market seems to be feeling the need for trust in stablecoins, transparency about reserves and collateral assets, and the need for related regulations. As a result, several institutions, including US financial regulators, are likely to take concrete actions to address the risks in the financial system.
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