Three Main Types of Stablecoins: From Principles to Applications in One Stop

Stablecoins have become an indispensable asset type in the crypto market. As a digital asset that is pegged to traditional assets (such as the US dollar and gold), stablecoins are changing the way we view crypto assets.

Detailed Explanation of Three Stablecoin Models

Currently, the stablecoins in the market can be divided into three categories: fiat-backed, crypto asset-backed, and algorithmic. Each model has its unique operational mechanism and application scenarios.

Fiat-backed stablecoins: The most straightforward solution

Fiat-collateralized stablecoins hold real fiat currency in bank accounts as reserves. For example, TrueUSD (TUSD) adopts a 1:1 model—each TUSD token corresponds to 1 US dollar in real dollar reserves.

Users can participate in the blockchain ecosystem by converting fiat currency into stablecoins and can also convert back. The innovation of TUSD lies in its use of Chainlink's Proof of Reserve (PoR) mechanism, allowing holders to independently verify the adequacy of reserves. This transparency design is relatively advanced among stablecoins.

The advantage of this model is that it is reliable and easy to understand, but there is a key risk: complete reliance on centralized institutions for the management of reserves. Once trust is broken, the consequences can be severe.

Crypto Assets Collateral: Decentralized Options

Stablecoins backed by crypto assets use a completely different logic—using crypto assets as collateral instead of fiat currency. Due to the high volatility of the crypto market, these types of stablecoins often require over-collateralization to maintain price stability.

For example, creating 100 DAI tokens requires collateral worth 150 dollars in crypto assets, resulting in a collateralization ratio of 1.5. This over-collateralization design is intended to cope with the severe fluctuations of the underlying assets.

DAI is managed by the MakerDAO community, where MKR token holders can vote on project decisions. When the price of DAI falls below 1 USD, market participants are incentivized to redeem tokens for collateral, thereby reducing circulation and driving up the price; and vice versa. This is a self-regulating system that utilizes game theory, fully executed by smart contracts, and users can audit the contract code themselves.

This model offers stronger decentralization features, but with higher management complexity, users need to understand the entire mechanism.

Algorithmic Stablecoins: The Most Ambitious Attempt

Algorithmic stablecoins do not require the reserve of any assets, but instead maintain their price by controlling the supply of tokens through algorithms and smart contracts. When the price falls below the target price, the system reduces the number of tokens in circulation (by burning, locking, or repurchasing); when the price exceeds the target, the system issues new tokens to increase the supply.

This model is the most aggressive of the three and the hardest to maintain stability. Historically, several algorithmic stablecoin projects have collapsed due to their inability to maintain price.

What Problems Do Stablecoins Solve

Bitcoin and Ethereum are highly volatile due to their limited supply and other characteristics. This provides traders with abundant speculative opportunities, but poses a barrier to everyday applications—no merchant is willing to make daily payments with volatile assets.

Stablecoins have changed this situation:

Real-world applications become possible. Those holding stablecoins can conduct daily transactions and international remittances with peace of mind, without worrying about prices dropping by 50% overnight. This is especially important for small businesses.

More Flexible Trading Strategies. Investors and traders can quickly convert their assets into stablecoins to lock in profits during market downturns, without having to withdraw funds back to the traditional financial system. This allows investors to operate flexibly in a blockchain-native environment.

Portfolio Risk Management. Allocating a certain proportion of stablecoin can effectively reduce the overall volatility of the investment portfolio while maintaining liquidity to seize market opportunities.

Core Advantages and Limitations of Stablecoins

Advantages: The construction of stablecoins on the blockchain means fast transaction speeds, low costs, and seamless cross-border transfers. The risk of double spending is nearly zero, making stablecoins an ideal tool for various application scenarios.

Limitations: Not all stablecoins can perfectly maintain their price peg. Historically, several projects have failed due to poor management or market shocks. Transparency is also an issue—many stablecoins only provide periodic certifications rather than complete public audits.

Moreover, fiat-collateralized stablecoins, due to reserves being managed by centralized entities, effectively grant these entities significant control over the stablecoins. Users must trust that the issuers actually hold the claimed reserves.

Collateralized and algorithmic stablecoins heavily rely on community governance - their security depends on the quality of the community's decision-making.

Regulatory Outlook and Market Position

Stablecoins are attracting the attention of regulators worldwide due to their unique nature that combines fiat currency and encryption. As stablecoins enable international instant transactions and low-cost remittances, some countries are even attempting to develop sovereign stablecoins.

According to the laws of the jurisdiction, stablecoins are likely to fall under the same regulatory framework as other Crypto Assets. For stablecoins that include fiat reserves, approval from regulators is typically required.

Applications of Stablecoins in Practice

In practice, stablecoins have become the liquidity hub of the crypto ecosystem. Many users hold stablecoins on exchanges to quickly seize market opportunities without frequently entering and exiting the fiat currency system.

Stablecoins also support lending protocols, derivatives trading, and payment applications, becoming the infrastructure of the decentralized financial ecosystem.

Rationally View the Risks of Stablecoins

Although stablecoins have become standard tools in the crypto market, their risks cannot be ignored. Some stablecoin projects have failed due to an inability to maintain price pegs, poor reserve management, or legal disputes.

Stablecoins are essentially still crypto assets, carrying all associated market and technical risks. Investors should manage risks through diversified portfolios, thorough research on the project's fundamentals, and other methods. Before participating in any stablecoin-related activities, be sure to conduct in-depth independent research.