Crypto

Non-Collateralised Stable Coins: What They Are & How They Work

Stable coins have risen to prominence over the years the cryptocurrency market has progressed. For traders and investors, they have grown to play a key role in limiting the potentially damaging impacts of negative market fluctuations.

And this is exactly what they were created to do, and are run in three ways. First you have Collateralised Stable Coins, which are Collateralised and pegged one to one with a particular currency or asset. Then came the Crypto- collateralised, that are backed by a reserve of a particular cryptocurrency like Ethereum. This particular article is focused on the third, Non-collateralised constable coins, which are not backed in any cryptocurrency or other assets.

 How do Non-Collateralised Stable Coins Work?

The inner workings of this type of stable coin revolve around a system known as the Seigniorage Share system. The stability of the coin’s market price is reliant on algorithms of a smart contract that make adjustments to the supply of the coin as a means of maintaining the coin’s price peg.

For example, should the demand for non-collateralised pseudo USD threaten to push the price above the $1 mark, the smart contract will begin the process of minting more digital assets to feed the market demand and maintain price stability. In the event of the opposite happening, the issuer will buy out the supply over flows caused by weakened demand.

However, should this coin “buy back” fail to keep the price at a stable peg, the aforementioned Seigniorage shares are put in play. In this instance, the issuance of these shares will entitle holders of the stable coin to a portion of future profits.

A few aspects of how this system works are in some ways similar to how a central bank independently controls the supply of a fiat currency, without the need to have the said fiat currency backed up by an actual asset like gold.

What Advantages Might They Offer?

  • The first benefit to the issuer is that they completely side step the responsibility of maintaining a reserve of a fiat currency or any other physical assets that would otherwise play the biggest role in holding a stable price.
  • In theory, this form of stable coin should represent a greater degree of decentralisation. Due to the fact that there are no regulated assets it is linked to, there should be a lot less regulatory compliance requirements.

 What’s the Downside?

  • The most noticeable potential risk related to these kinds of stable coins is a unique vulnerability to a serious market downturn. Non-collateralised stable coins may prove very difficult to redeem in that scenario.
  • At its heart, the system is fueled by trader/investor demand. Demand in this already well served market is not guaranteed.
  • The mechanics of the system are a tad bit more complicated than those of their collateralised counterparts. This may interest some individuals, while on the other hand make others mistrust the coin. It could either way.

Conclusion

This is a segment of the market that may see a lot of growth and development in the coming years. It will be very interesting to see how the constant evolution of the entire market influences this side of the blockchain.

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Joel Bonga

A part time cryptocurrency trader, mostly a hodler, and Blockchain/crypto freelance writer. Plus an occasional contributor at BIZZNERD.
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