Comdex’s Stablecoin: Type and Backing Mechanisms
It has come to the knowledge of the crypto community that Comdex has been working on its overcollateralized stablecoin, the Composite $CMST. The stablecoin is meant to service the whole Cosmos ecosystem.
Let’s see what a stablecoin is, and the types of stablecoins available, paying more attention to why Comdex chose $CMST to be the type that it is.
A stablecoin is a cryptocurrency whose value is pegged, or tied, to that of another currency, commodity or financial instrument. They aim to provide an alternative to the high volatility of the most popular cryptocurrencies including Bitcoin (BTC), which has made such investments less suitable for wide use in transactions.
Most stablecoins are pegged to the USD, having the equivalent of $1.
Stablecoins are seen as a way of storing wealth, since its value does not change over time, unlike most other cryptocurrencies.
Types of Stablecoins
There are different types of stablecoins based on the mechanism used to stabilize their value. Let’s take a look at each of them:
- Fiat-Collateralized Stablecoins: This type of stablecoin is backed by fiat currency. They maintain a reserve of a fiat currency (or currencies) such as the U.S. dollar, as collateral assuring the stablecoin’s value. Some other collaterals can include precious metals like gold or silver as well as commodities like crude oil. Their reserves are maintained by independent custodians and are regularly audited. They can be issued by third party centralized entities like banks that have custody of your fiat currency. For instance, if a user has a dollar ($1) in a bank, that user can be given a stablecoin that represents that dollar. At every point in time, the stablecoin represents $1 and the user can redeem their money from the bank with the stablecoin, and that is the main assurance they have on the coin. Examples of such are the USDC and USDT. The major challenge with this type of stablecoin is with the custody of users’ fiat currency. Since the centralized party is in custody, it can decide to restrict the wallet based on the activities going on in the wallet. Therefore, the centralized third party must be a trusted entity. TrueUSD (TUSD) is a popular stablecoins backed by U.S. dollar reserves and denominated at parity to the dollar.
- Crypto-Collateralized Stablecoins: Crypto-collateralized stablecoins are those that are backed by other cryptocurrencies. This would mean that they are distributed by Decentralized Finance (DeFi) protocols and not centralized entities. They exist on-chain. When investors deposit cryptocurrency to the protocol, they receive stablecoins. Since the reserve cryptocurrency may also be prone to high volatility, such stablecoins are over-collateralized—that is, the value of cryptocurrency held in reserves exceeds the value of the stablecoins issued. To redeem their crypto assets, the investors have to repay the stablecoins with fees. The challenge with this type of stablecoin is that over-collateralization leads to lower capital efficiency. They are highly dependent on the smooth functioning of their liquidation mechanism, so any failure of liquidation can cause severe issues in the peg of the stablecoin. For example, $DAI was backed by $ETH, but on Black Thursday, when $ETH dipped nearly -45% in a day, they were exposed to the de-pegging of $DAI, which led to a death spiral scenario.
- Algorithmic Stablecoins: Algorithmic stablecoins may or may not hold reserve assets. Their primary distinction is the strategy of keeping the stablecoin’s value stable by controlling its supply through an algorithm, essentially a computer program running a preset formula. An example is the TerraUSD ($UST). The price of the TerraUSD (UST) algorithmic stablecoin plunged more than 60% on May 11, 2022, vaporizing its peg to the U.S. dollar, as the price of the related Luna token used to peg Terra slumped more than 80% overnight. The challenge here is that the model is ineffective. It relies on a mechanism that aims to keep the price stable by expanding and contracting the supply of stablecoin. They can be potentially undercollateralized.
Some Features of $CMST
Let’s now take a look at some characteristics of the over-collateralized Composite $CMST.
- The $CMST stablecoin is both a fiat-collaterized stablecoin backed by the $USD, and a crypto-collateralized stablecoin.
- Fiat-collaterized models usually have custody and blacklisting problems, but this is not the case with $CMST since it is from a decentralized protocol. Everything going on with the stablecoin is transparent and can be seen on the chain. $CMST reduces the risks associated with fiat-collaterized stablecoins, while also maintaining its peg of 1:1.
- To maintain the health of the system in any case of exceeding debt, the $HARBOR token of Harbor protocol will be used. It will also be the final backstop to re-peg $CMST token in secondary markets (during catastrophic events). Through the Harbor platform, users can deposit their assets as collateral in order to mint new $CMST. However, a gas fee is charged for minting and redeeming the protocol.
The use of cryptocurrencies as collateral for loans is expanding, and so there is a demand for a lending market in the Cosmos ecosystem. For example, assume you have a large stack of $ATOM and don’t want to sell it, but you notice a short-term potential to profit, and the only alternative you currently have is to sell your $ATOM to access liquidity to seize the opportunity. With a money market in place, you can collateralize your $ATOM, take a $CMST loan against it, take advantage of the opportunity, and repay the loan.
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