As the name itself suggests, cryptocurrency-backed stablecoins (CBSs) are a category of stablecoins backed by cryptocurrencies, or other crypto assets, used as collateral. The working principle is analogue to that one on which fiat-backed stablecoins (FBSs) are based but, while FBS collateralization process usually takes place “off-the-blockchain”, that one of CBSs takes place “on-the-blockchain”.
In the collateralization process, users take out a loan against a smart-contract via locking up collateral, making it more rewarding to pay off the debt should the CBS’s value decrease. In order to avoid sudden crashes, a loan may be liquidated by the smart contract should the collateral decrease too close to the value of the withdrawal.
The CBSs have specific characteristics. First, their value is collateralized by a cryptocurrency or another crypto asset, on the blockchain, via smart contracts, as we wrote. The price stability is granted by supplementary instruments, not just by the collateral. The complex collateralization process on which CBSs are based on generates a great risks of exploits, due to possible bugs in the smart contract code. As the tethering is done on blockchain, it is not subject to third party regulation. Problems arise due to the change in value of the backing cryptocurrency and the affordability of supplementary instruments. The complexity and non-direct backing of CBSs impede their diffusion on the market, as it is not always easy to evaluate the true underlying price. Since cryptocurrency market is highly volatile, the CBSs collateral must be elevated, in order to ensure the CBS’s value stability.
The most notable examples of CBSs are: Havven (pair: nUSD, stablecoin and HAV, collateral-backed nUSD), DAI (pair: CDP, Collateralized Debt Position and MKR, governance token used to control the supply).