May 19, 2022

How stablecoins stay stable, explained

Crypto-backed stablecoins use what amounts to overcollateralized loans to keep their value correctly pegged.

Crypto-collateralized stablecoins are backed by a basket of one or more other cryptocurrencies. As these are themselves highly volatile, these stablecoins are highly overcollateralized, and require purchasers to lock their collateral tokens into smart contracts that will be liquidated if the collateral drops in value too much. The collateral that can be collected by replacing the stablecoins. 

One of the best-known crypto-backed stablecoins is MakerDAO’s DAI, pegged to $1. However, as MakerDAO learned during the March 12, 2020 “black swan” event in which ETH’s value was cut in half in less than 24 hours after it got overwhelmed by liquidations, making sure the system can handle extreme conditions is vital — forcing it to implement substantial governance and auction management changes. That was successful, and the stablecoin’s market capitalization is more than $4.8 billion at this writing.

It is getting some competition this summer from Free TON, the fully decentralized blockchain project that took up the Telegram Open Network blockchain’s work once the messaging company that founded it pulled out after a legal battle. 

This summer, Free TON is planning to release a stablecoin sibling to its TON Crystal token. The stablecoin’s liquidity will be 100% backed by locked-in Ether, providing liquidity providers with potential returns. It will have “widespread application for services with recurrent subscriptions and high-risk offerings,” said TON Labs, the core developer of the Free TON project.

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