How Does Collateralization Differ between Centralized and Decentralized Stablecoins?
Centralized stablecoins are typically backed 1:1 by fiat currency (like USD) or short-term treasuries held in a bank account, with the issuer holding the reserves. Decentralized stablecoins are backed by crypto assets, often in an over-collateralized manner, managed by transparent smart contracts on a blockchain.
The key difference is the custody and transparency of the reserves: centralized is trust-based, decentralized is trustless and auditable on-chain.
Glossar
Smart Contracts
Function ⎊ Smart contracts are self-executing agreements with the terms of the agreement directly written into lines of code, residing on a decentralized ledger.
Decentralized Stablecoins
Collateralization ⎊ Decentralized stablecoins mitigate systemic risk inherent in centralized models through varied collateralization mechanisms, often employing over-collateralization to maintain peg stability.
Fiat Currency
Foundation ⎊ Fiat currency, within the context of cryptocurrency and derivatives, represents a governmental legal tender not backed by a physical commodity; its value is declared and maintained by the issuing nation’s regulatory framework, influencing the pricing and settlement of crypto-based financial instruments.
On-Chain Transparency
Feature ⎊ On-Chain Transparency refers to the inherent characteristic of public blockchain systems where all transaction data, including trade executions, collateral deposits, smart contract logic, and reserve balances, are permanently and publicly verifiable by any market participant.
Collateralization
Security Deposit ⎊ Collateralization is the process of securing a financial obligation, particularly in margin trading or lending protocols, by locking up an asset of greater value than the liability being assumed, thereby providing a buffer against potential loss.
Stablecoins
Peg ⎊ Stablecoins represent a class of cryptocurrencies designed to maintain a stable value relative to an external reference asset, typically a fiat currency like the US dollar.