What is Collateralized Stablecoin?
Let's find out Collateralized Stablecoin meaning, definition in crypto, what is Collateralized Stablecoin, and all other detailed facts.
A collateralized stablecoin is a type of stablecoin that is partly or entirely backed by collateral that is held in a reserve. Stablecoins are blockchain-based digital assets that have their price pegged to a specific asset, at a designated price. This can be the value of assets like gold or fiat currency like the US dollar. For example, 1 Tether (USDT) is worth 1 USD.
The backing is required for a stablecoin to maintain its legitimacy and utility as a payment method. The backing used for stablecoins is known as collateral.
Some of the best-known examples of fully-collateralized stablecoins are Tether (USDT), USD Coin (USDC), and DAI; the latter is generated via the collateralized debt position (CDP). The collateral allows token holders to redeem them for US dollars or other assets which can be used in the traditional market.
Collateral used for stablecoins can take different forms, like cash, commercial papers, or bond purchases. The collateral can be used for further investment opportunities and help improve capital efficiency.
Decentralized stablecoins are cryptocurrencies that commit their collateral solely to on-chain assets instead of traditional financial assets.
Collateralized stablecoins require immense amounts of capital to maintain trust and legitimacy. Their stability directly depends on the collateral they are pegged to. In order to minimize value fluctuations, many collateralized stablecoins must be overcollateralized.
Unlike collateralized stablecoins, algorithmic stablecoins like RAI, FEI, or FRAX use smart contracts to maintain stable supply and value. These smart contracts manage the supply and maintain the pegged value stable by buying, selling, and, when necessary, burning tokens.