Is it safe to assume we all know what stablecoins are? Okay, I agree, let’s not assume.
stablecoins are digital currencies minted on the blockchain whose value is pegged to another asset class, with the intent of holding a stable value (ie 1 USDollar : 1 USDCoin). There are four different types of stablecoins identifiable by their collateral structures; namely, fiat-backed, crypto-backed, commodity-backed, or algorithmic stablecoins. Though their underlying collateral structures may vary, all these stablecoins aim for the same goal: stability. Since stablecoins rarely fluctuate significantly in price, they are designed to be used (transactional) rather than as an investment (spectulative).
Let us look briefly into these different types of stablecoins, their collateral structures and drawbacks, and how they may play into the design of a much better stablecoin.
Fiat-backed stablecoins: Some of the most popular stablecoins are backed by a fiat currency ie government-issued currency like the US Dollar. These stablecoins have fiat collateral that remains in a reserve with a central issuer or financial institution and must proportionate to the number of stablecoins remaining in circulation. For instance, if an issuer has $1 million of fiat currency, it can only mint/distribute 1 million stablecoins, each worth one dollar (ie 1 USDollar : 1 USDCoin).
What drawback may a fiat-backed stablecoin have? as you may have guessed, is inflation. Suppose the asset backing these stablecoins is controlled by the government. In that case, that means the government (ie central banks) has control over how much and fast, money is printed, leading to inflation, and in places with weaker institutions, hyperinflation. As more money is printed, prices go up proportionally. Also, the stability of the coin is threatened or funds are lost if the issuer of this stablecoin defaults (ie centralization, there’s a central point of failure).
Crypto-backed stablecoins: These stablecoins are backed by another cryptocurrency as collateral, so they make use of smart contracts, and happen on-chain instead of relying on a central issuer. To have this kind of stablecoin, a user will have to lock their cryptocurrency into the protocol’s smart contract to obtain an equal value of the stablecoin, depending on the collateralization ratio. Should you want back your collateral, for example, ETH, you will need to put the same value of stablecoin back into the smart contract to withdraw your collateral.
These kinds of stablecoins are usually over-collateralized to buffer against price fluctuations in the required cryptocurrency collateral asset. So, lets say you want $1 million worth of stablecoins, you will need to deposit $2 million worth of collateral asset ETH, this equates to a 200% collateralized ratio, insuring a 50% decline in the collateral currency. If the price of ETH remains above a pre-set threshold, the excess collateral buffers the stablecoins price to maintain the peg (ie stability). However, if the price of ETH falls below the pre-set threshold, collateral is paid back into the smart contract to liquidate the position so as to maintain the peg (ie stability) also.
A major drawback is a collateral liquidation. It is important to note that these stablecoins can, and are more likely to, fluctuate in price than fiat-backed stablecoins and therefore have the potential to go off-peg and in case of it going really off-peg, the underlying crypto collateral asset will have to be liquidated to maintain the peg (ie stability).
Commodity-backed stablecoins: These digital currencies are backed by real-world assets such as real estate, gold, oil, or other tangible physical assets or commodities. They are designed to offer greater access to investors who want to invest in cryptocurrency but want something more reliable, which is tied to the value of a physical underlying asset (collateral). For example, Paxos Gold (PAXG) is pegged to the price of Gold, and Venezuela’s Petro stablecoin is pegged to the price of a barrel of oil.
The main drawback here lies in their centralization i.e. dependence on one specific source of data transmission. It is also important to remember that these commodities can, and are more likely to, fluctuate in price and therefore have the potential to lose value, and affect the price of the stablecoins they are returning.
Algorithmic Stablecoins: For these stablecoins, there may or may not be a collateral asset. Instead, price stability is maintained by the use of specialized algorithms and smart contracts running a preset formula. An algorithm stablecoin smart contract will reduce (burn or buy-triggers) the number of coins in circulation when the market price falls below the price of the fiat currency it tracks, and mint new tokens into circulation if the price of the tokens exceeds the price of the fiat currency it tracks.
Drawbacks? Depending on who you ask, uncollateralized algorithmic stablecoins are seen as very risky. Here’s a video by Nevin highlighting that with some panelists. In some ways, algorithmic stablecoins issuers are not so different from central banks, which also don’t rely on a reserve collateral asset to keep the value of the currency they issue. The difference is that a central bank (like the US Federal Reserve) sets monetary policy publicly based on well-understood parameters, and its status as the issuer of legal tender does wonders for the credibility of that policy. Algorithmic stablecoins issuers can’t fall back on such advantages in a crisis. The price of the TerraUSD (UST) algorithmic stablecoin plunged more than 60% on May 11, 2022, vaporizing its peg to the US dollar as the price of the related Luna token used to peg Terra slumped more than 80% overnight.
The Better stablecoin
What if we can design a much better stablecoin, learning from all the new and old issues, incorporating the good, and avoiding the pitfalls? What if we can create a decentralized stablecoin that’s independent of fiat monetary systems with the overarching goal of addressing the effects of hyperinflation? What if we can RESERVE!
Reserve offers a much different and innovative approach to stablecoins, with currencies that don’t inflate. How is that even possible, you may ask. History says currencies have always flattened and will continue to. So how is it possible to create one that won’t inflate?
Here, Nevin Freeman painted a really good picture about how the wealthy have already solved the issue of inflation by not keeping their money in currencies, because they know that even the strongest currencies like USD and GBP are losing value all the time. What they do is keep their money in a very diversified basket of assets like stocks, gold, bond, real estate and only convert a portion of these assets back to local currencies to cover short-term expenses.
Reserve’s The idea is to aggregate all of these diversified sets of assets and make a currency out of them, an asset-backed currency, one which is independent of fiat monetary systems. What this offer is stability for people; Where a dollar in their hands today is worth relatively the same dollar 50 years from now, in fact in infinite years. The name for these asset-backed stablecoins built on the Reserve Protocol is RToken, and it is permissionless (ie anyone can create it).
At the core of a better stablecoin, one which the Reserve Protocol is proposing through the creation of RTokens is governance, revenueand insurance to protect holders of these stablecoins (RTokens) from inflation and loss.
The current governance structure in web3 has some issues, one is that the rich get all the voting power since token to voting power is 1:1. Reserve proposes something different where we delegate the decisions that need to be made to the best people that need to make them and at the same time maintain alignment among all the various stakeholders involved to make sure that the best things happen to everyone involved. From collateral baskets to back RTokens, to an ordered list of emergency collateral, to how portions of revenue are distributed to RSR stakers, to incentivize RSR holders to stake and provide insurance, here Governance is different.
With revenue, RTokens accrue revenue from their collateral baskets (ie assets backing these RTokens) including tokenized outputs. Revenue can come from yield from lending collateral tokens on-chain, transaction fees and/or revenue shares with collateral token issuers. These tokens are designed to be ever-increasing against their base tokens, as they are pegged to the value of the base token + any borrowing/trading fees paid in the relevant pool. This revenue helps to maintain the peg (ie stability) for the stablecoins, governance and incentivizing RSR stakers to keep insuring the stablecoins.
RTokens can be insured, which means that if any of their collateral tokens (ie assets backing the currency) default, there’s a pool of value to make up for the loss. RToken insurance is provided by Reserve Rights (RSR) holders, who may choose to stake their RSR on one or multiple RTokens. Staked RSR can be seized in the case of a collateral default in a process that is entirely mechanistic based on chain price-feeds, and does not depend on any governance votes or human choices. The possibility of a loss of staked assets by stakers in the event of a default encourages stakers to back and vote on issues that help make good things happen to the stablecoins.
Reserve believes decentralized stablecoins that are community owned have the potential to play an important role in the future of global finance. These community-run & owned (DAO, multi-sig or single Ethereum address) stablecoins can set and select the basket that backs the RToken including the backup asset in the case of a default and the projects they want to support with their RToken.
Governments With real-world assets such as real estate, gold, oil, or other tangible physical assets or commodities can collateralize these assets to create a RToken to fund projects for their countries without going to loan sharks in the form of governments and international money lenders to bail them out. Governments also don’t have to pay inflating interest rates as their currency devalues against the currency from which they borrowed which is usually the US dollar. This will also help governments act more responsibly in how they manage their citizens’ funds, as the people and other stakeholders tend to be part of the governance structure of the token.
Communities can come together, collateralize their assets and create RTokens, to fund projects that matter to them. From funding education to healthcare, buying NFTs, or setting up a pension fund. Questions like how do one create the best retirement portfolio, what is the optimal portfolio for a retirement account, 60/40 equities/bonds? These questions are what an innovation like the Reserve protocol facilitates, which is to allow the market (Communities, DAO, people) to discuss what is the optimal thing for them. As more and more assets are tokenized and come on-chain we will have collateral baskets with real estate, commodities, equities, stocks… The goal is that people can compose these different assets, stablecoins, defi primitives to create what they think are the best stable assets for them and their communities.
I know I must have said a lot about the Reserve protocol, but I’m sure I haven’t said enough. Perhaps it’s time you get into the Reserve protocol and read about what the team is doing, go to the Register Dapp and create a new RToken.
Be part of the movement. Our currency should not inflate, our currency should be decentralized.
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