Stablecoins are fiat currencies used in blockchain networks, typically pegged to the price of fiat currencies, audited by third parties, and backed by real USD reserves or complex algorithms to ensure their price stability. Depending on the method of price stabilization, stablecoins can be divided into three categories: USD-collateralized stablecoins, overcollateralized multi-asset pool stablecoins, and algorithmic stablecoins.
USD-collateralized stablecoins: Examples include USDT and USDC, as well as exchange-issued stablecoins such as BUSD and HUSD. They are centrally managed, backed by USD, and can be exchanged at a 1:1 ratio. The issue lies in whether these centralized institutions, backed by brand reputation and trust, can guarantee sufficient USD reserves. Tether, the issuer of USDT, admitted in 2019 that USDT supply was not 100% backed by USD. Meanwhile, in this year's on-chain stablecoin trading volume exceeding $1 trillion, USDT accounted for about 73%. Additionally, regulation is a Sword of Damocles hanging over centralized institutions, and the question of when it will fall is becoming increasingly urgent.
Overcollateralized multi-asset pool stablecoins: Examples include MakerDAO’s DAI and Synthetix’s sUSD. They are overcollateralized by crypto assets and rely on price oracles to maintain their USD peg. Unlike centralized tokens such as USDT and USDC, they can be minted without permission. The advantage of the overcollateralization model is that it does not require asset pricing and can quickly provide liquidity. However, the nature of overcollateralization means capital is overly concentrated, and the highly volatile and correlated nature of crypto assets has historically made these stablecoins vulnerable to shocks affecting the entire crypto market.
Algorithmic stablecoins: These are currencies that automatically adjust their supply mechanism based on algorithmic programs. When the stablecoin price is above the peg, the supply increases; when it is below the peg, the supply is reduced, or arbitrage opportunities are provided to balance the price. This model does not peg to real fiat currencies nor requires collateral, relying entirely on market sentiment and algorithms for regulation—hence also called elastic money. Algorithmic stablecoins represent the most significant effort in the crypto space to pursue native stablecoins, as they are not generated through asset collateralization but by leveraging people’s profit-seeking behavior. Moreover, they possess features absent in previous stablecoin experiments: they are crypto-native and have the potential to achieve true decentralization for the first time. This year, the surging performance of ESD, BASIS, and FRAX, led by AMPL, has reshuffled trading rankings, prompting the industry to take algorithmic stablecoins more seriously.
Several algorithmic stablecoins in the market draw inspiration from the market operations of traditional central banks. Their price pegs are weaker because there is no real arbitrage mechanism for their pegs—their operation resembles central banks setting price range targets. Monetary policy operates slowly, and when the currency deviates from its peg, the central bank does its best to react in real time. The mechanism behind decentralized price pegs can function effectively in highly volatile markets.
