Stablecoins in Cryptoeconomics: From Initial Coin Issuance to Central Bank Legal Digital Currency -Part 2

b. Different types of stablecoins

There are three main types of stablecoins on the market, each of which uses a different model to stabilize its value.

The first type backed by legal currency assets depends on legal currency as collateral, so it cannot be completely decentralized, which can also be called an off-chain collateralized stablecoin.

The second is the on-chain collateralized stablecoin, which is usually collateralized by digital assets of one or a basket of cryptocurrencies. This type is completely decentralized because the decentralized system cannot use mortgage assets outside the blockchain. In principle, the on-chain collateralized stablecoin helps to increase the transparency of issuance and transactions.

The third one is non-collateralized stablecoins, which use algorithmic tools to maintain stability. As Robert Sams explained in a seminal paper, Bitcoin-like cryptocurrencies “manage the money supply through simple and definite money supply rules.” For this reason, any change in the demand for such stablecoins may affect the price, which will result in significant price fluctuations and limit the utility of stablecoins as a medium of exchange.

In addition to the three main categories mentioned above, there are another two types of stablecoins: hybrid stablecoins and alternative stablecoins. Hybrid stablecoins combine off-chain and on-chain stability mechanisms, such as the financial reserve. An example of an alternate stable currency is “Terra”, a cryptocurrency whose price is pegged to the basket of currencies.