Stablecoin design analysis- Part 3: Decentralized/no collateral
Given the two previous parts of this series we examined the benefits and drawbacks for centralized stablecoins and crypto-collateral stablecoins, it can be easy to assume that developers have run out of stablecoin models that give users the peace of mind and store of value that they are seeking. However, there is another more major model that is sometimes utilized when stablecoin projects are released and this model is known as the decentralized or no collateral model. Let’s dive into this third stablecoin model to learn more about what it entails and how it is designed to alleviate the volatility issues of common cryptocurrencies.
What Is the Decentralized/No Collateral Stablecoin Model?
Whereas our two previous models focused on backing the stablecoin either with cryptocurrency or with fiat currency as a means to bring down the level of volatility and stabilize the price of the coin, the decentralized/no collateral stablecoin model does not rely on a backing mechanism in order to make for a more stable asset. How does it achieve this? Rather than operating off of real or digital currencies, a decentralized/no collateral model will utilize smart contracts to issue tokens at a certain price. If the price becomes too high, the algorithm will begin producing more coins to lower the price or if the price is too low, the system will burn coins instead.
Advantages and Disadvantages of the Decentralized/No Collateral Stablecoin Model
While the decentralized/no collateral is definitely one of the more unique stablecoin models to date and offers safeguards that other models are unable to provide, that does not mean that it is without its faults. Let’s evaluate some of the advantages and disadvantages of this stablecoin design. Here are some of the benefits that come with using this model.
● The model is decentralized, making it possible to put more trust and confidence in the system
● Since the system relies on technology rather than assets, it can attempt to stabilize itself when prices change
● Unlike other models, there is no limit on the number of existing coins, allowing for demand to grow and prevent it from becoming so high that the price rises significantly
The decentralized/no collateral stablecoin model may offer better safeguards than some other stablecoin models but there are still issues with the model that could be problematic for owners of the coin. Let’s take a look at a few of these disadvantages.
● This model is heavily reliant on the user base. If confidence is lost, there will be no price or coin to maintain
● The project must be able to continually grow, or the project will not be able to maintain the set price of the coin
● It can be harder to come up with clear calculations regarding performance as most potential situations are largely experimental or theoretical
It needs to be noted that Basis is a well-known company to attempt this model. But as shown, issuers must manipulate the price to maintain stability, making the token a security under US laws. This hinders development but is something issuers must take into consideration for the benefit of all their supporters and the blockchain industry at large. Developers must build solutions that can scale, if not we all lose, even if we did not invest in the project.
Now that you have a clear picture of the three major types of cryptocurrency “stability” models that are currently being utilized in the market today, we are going to cover a very special hybrid model in part four that will change the way you look at stablecoins.