When people hear the word “stablecoin”, they generally think about a digital asset tied to another asset of stable value in order to ensure stability. Further breaking this down, many people will think of projects such as Tether to better understand what a project like this is meant to do and how it operates. This is arguably one of the more well-known stablecoin projects on the market, but you may be surprised to learn that there are a handful of others that utilize different structures in order to achieve the same purpose. While developing Jointer, we analyzed a multitude of stablecoins in order to decide what currencies to support. In this four-part series, we are going to examine each of these models in order to gain a better understanding of what they seek to accomplish and their effect on mass adoption.
In this first section, we are going to look at the Centralized/Fiat Collateral model used in stablecoins.
Centralized/Fiat Collateral Model in Stablecoin Technology: How Does It Work?
In a centralized/fiat collateral model, a stablecoin developer will create a cryptocurrency asset that will be backed by a fiat currency. Tether does follow this model and is a perfect example for a case like this. While the currency that backs the coin could vary on the developer’s choosing, the principle is that each coin is backed by say, a dollar, whose value is stable and unlikely to change. The developer or company behind the coin will place a certain amount of currency within a bank account and then release the same number of coins that reflects that balance. This way, users can trade in their coins for the currency that backs it. The coin essentially represents that fiat store of value.
Advantages and Disadvantages of This Model
The biggest issue with this model is that it comes with drawbacks. To begin, here are the pros that come with using a centralized/fiat collateralized structure:
- Most stablecoins utilizing this model generally retain their stable value on the market fairly well
- There is the added security of having the fiat backing the crypto stored in a bank account
- These assets are less susceptible to factors behind volatility that impact other crypto assets
Despite some of the advantages of this model, it does come with its fair share of disadvantages such as:
- Long-term, countries will issue their only fiat collateralized tokens making developer tokens lose intrinsic value on the market. Why buy from some company when you can buy directly from another a top rated government?
- Developers who centralize their models have full control over your funds as the coins are not valuable on their own
- Developers and companies could easily lie about having a certain amount of money in the bank account to back the coin
- Stablecoins are still volatile, although significantly less than other currencies, and are still susceptible to speculation
- Developers control the price to try and reduce that volatility potentially categorizing them as securities
As you can determine from the characteristics listed above, there are far more significantly dangerous disadvantages than there are to positives of using this coin. If you’re curious about what other models exist, continue reading our series in which we will cover decentralized/crypto collateral-based stablecoin methods!
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