Stablecoin Governance: A Market Overview of Major Stability Protocols
Chief Make-It-Happen Officer, Non-profit Marketing Chair, DLT Advocate, and Investor in Blockchain
When people hear the word “stablecoin”, they generally think about a digital asset tied to another asset of stable value in order to ensure stability. Further breaking this down, many people will think of projects such as Tether or the soon to be “Libra” to better understand what a project is meant to do and how it operates.
Tether is arguably one of the more well-known stablecoin projects on the market but you may be surprised to learn that there are a handful of others that utilize different structures in order to achieve the same purpose.
While developing Jointer, we realized that a stablecoin was necessary to operate our business model across real estate and blockchain so we looked to the market and here is what we found:
1. Centralized/Fiat Collateral Model
In a centralized/fiat collateral model, a stable coin developer will create a cryptocurrency asset that will be backed by a fiat currency. Tether follows this model and is a perfect example for a case like this.
While the currency that backs the coin could vary on the developer’s choosing, the principle is that each coin is backed by say, a dollar, whose value is stable and unlikely to change.
The developer or company behind the coin will place a certain amount of currency within a bank account and then release the same number of coins that reflects that balance. This way, users can trade in their coins for the currency that backs it. The coin essentially represents that fiat store of value.
Advantages of Centralized Stablecoins
- Long-term, countries will issue their only fiat collateralized tokens making developer tokens lose intrinsic value on the market. Why buy from some company when you can buy directly from another a top-rated government?
- Developers who centralize their models have full control over your funds as the coins are not valuable on their own
- Developers and companies could easily lie about having a certain amount of money in the bank account to back the coin
- Stablecoins are still volatile, although significantly less than other currencies, and are still susceptible to speculation
- Developers control the price to try and reduce that volatility potentially categorizing them as securities
2. Decentralized/crypto collateral
Unlike the centralized/fiat collateral model, the decentralized/crypto collateral stablecoin model seeks to satisfy the needs of cryptocurrency enthusiasts while also seeking to shield them from some of the instability that comes with using crypto assets by themselves.
In a decentralized/crypto collateral stablecoin model, stablecoins are backed by various cryptocurrencies that users must “stake” a certain amount of to attempt to stabilize the price by limiting sell pressures.
Once those requirements are met, the mix of cryptocurrencies are locked into a smart contract and the stablecoins are created and sent to the user’s wallet. With this model, users will over-collateralize the stablecoin in order to make sure that it can withstand any price changes. Tokens issued under this model are most likely securities under US laws.
Advantages of Decentralized/Crypto Collateral Stablecoins
- Decentralization, which fosters greater trustlessness
- Efficient nature due to utilizing multiple cryptocurrencies. Using a single cryptocurrency would heighten liquidity risk at times when stability needed to be achieved through selling
- Since these assets are over-collateralized, it helps to guard against volatility that often strikes across multiple assets
Disadvantages of Decentralized/Crypto Collateral Stablecoins
- Even though it is designed to help shield the user from some of the volatility, this model is still more volatile than models backed by fiat or commodities.
- If a cryptocurrency’s value falls below a certain threshold, it will be instantly liquidated, which is a severe issue if this should happen to more than one of the cryptocurrencies backing the stablecoin.
- Utilizing several different cryptocurrencies can often be a complex process for developers, which can result in issues for the user if the project is not carried out correctly.
- They all may classify as securities yet do not register as such. This regulatory oversight on behalf of the issuers shows a lack of seriousness about mass adoption.
3. Decentralized/no collateral
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 of Decentralized/No Collateral Stablecoins
- 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.
Disadvantages of Decentralized/No Collateral Stablecoins
- 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
4. Volatility-free EZO hybrid
In the previous sections of this article, we covered three major stablecoin models: the centralized/fiat collateral model, the decentralized/crypto collateral model, and the decentralized/no collateral model. Each of these models has something unique to offer that is designed to target and minimize the volatility in the cryptocurrency industry.
For the most part, developers in the cryptocurrency industry have produced products that have used these types of stablecoin designs to craft their own digital currencies. For example, Facebook’s Libra is a centralized model that is pegged to multiple currencies, and will still have volatility.
One company, has taken sections of various models in order to come up with a stablecoin that would provide a product for the general product, free from control and centralization. In this section, we are going to cover the volatility free hybrid protocol and the benefits plus potential shortcomings it provides users. More specifically, we want to cover how the Element Zero coin functions and what it will be able to do.
The Hybrid Decentralized Collateral/No Collateral System
Put simply, Element Zero uses a decentralized collateral/no collateral that manages to overcome the demand issues present in collateralized systems. All the while, preventing the system from facing potential disasters that could happen if the system is overloaded with requests in the event too many people are looking to sell their stablecoins at the same time. (This is the concern JP Morgan recently raised in regards stablecoins)
Having too much demand or too little demand are both volatile situations for a stablecoin project and Element Zero can potentially successfully sidestep these issues with their hybrid system.
Advantages of the Hybrid Decentralized Collateral/No Collateral System
- Consistently monitoring the performance of other currencies and tracking inflation via API’s, measuring the Liquidity Reserve against the U.S. dollar based on multiple leading exchanges that follow the median buy and sell rates listed on these exchanges. It will also maintain liquidity by evaluating the BTC and ETH micro-trades and pricing and through the use of the Personal Consumption Expenditures Index and the Consumer Price Index, providing the platform with a multi-market assessment that is extremely comprehensive.
- Maintaining a value locked price of $100 that eliminates the fear or panic that accompanies volatile cryptocurrencies and high demand. The value of EZO will increase with inflation
- Users who want to sell or redeem their stablecoins will be able to do so at any given time, without the fear or panic that comes with high supply.
- Rather than processing redemption orders on a first-come-first-serve basis, which can be unfair to users who simply are not quick enough to beat out other faster users or those attempting to cheat the system, orders will be filled on a pro-rata basis once every 24 hours.
- There is a circuit breaker mechanism that activates slow and halt trading mechanisms when coins such as BTC and ETH start to appreciate and trading increases. When this happens, it can indicate that there is more demand for regular cryptocurrencies and less demand for stablecoins, especially if there is a large jump in price and a desire to invest and profit from cryptocurrencies. This will give users the opportunity to trade in their stablecoins and will protect the system from too many requests at once.
- SmartSwap is still in TestNet
- The token is still in beta testing
- Element Zero will have to release EZObeta without inflation before EZO due to SEC compliance
- Volume is not present without a live trading token
- No Currency, Commodity or Collateral Needed
- Inflation Protection Against USD Volatility
- An open-source, turn-key platform
- Not-for-profit status
Jointer is the parent company of the not-for-profit stablecoin, Element Zero. The Author is a Co-Founder of Jointer and oversees Element Zero from a Chair position.
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