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Published on 
8 September, 2022

What is a stablecoin and why is collateral more important than interest rates?

Key insights: 

  • Stablecoins are digital currencies pegged 1:1 to an asset, usually the US dollar. 
  • There are different types of stablecoins and learning about what backs each one will help you better understand their features.   
  • There are different mechanisms and platforms that allow you to deposit stablecoins and get an interest rate. 

The words cryptocurrency and stable can sound like antonyms, especially when 99% of Bitcoin headlines refer to its volatility. Along this article we will deep dive into what stablecoins are, how they work and what they are used for. 

What is a stablecoin? 

A stablecoin is a cryptocurrency or digital token created to remain stable, at 1:1 parity with a given asset. In order to achieve this, stablecoins must be backed in other assets, most commonly financial assets, fiat currencies or even other crypto assets. 

Most stablecoins are pegged to the US dollar, since this is the currency that acts as the value standard for the global economy. However, they can follow the price of other currencies such as euro or Mexican peso or assets such as gold or oil barrels, or even security baskets. 

How were stablecoins created?

Stablecoins were created as an alternative to withdraw the funds from exchanges without needing to use a bank account. Nevertheless, its use has evolved. 

In 2014 the first initiatives for digital assets with a stable price reached the cryptomarket. Stablecoins were initially used by traders that needed a way to withdraw their funds from crypto exchanges without going through bank accounts. This happened because, out of lack of knowledge on the matter, financial institutions would rather not receive funds coming from crypto exchanges at the time. 

No one truly envisioned while creating the first stablecoins what a cryptocurrency pegged to the value of an asset, such as the US dollar, could become what they are today: a digital, non-volatile and low cost means of payment that is also used as protection against the devaluation of fiat currencies in underdeveloped countries, as well as against bitcoin’s volatility. 

Stablecoins are a digital, non-volatile and low cost means of payment, and used to protect from bitcoin’s volatility.

Types of Stablecoins: 

The way each stablecoin works is determined by the protocols that issue them. There are different types of stablecoin protocols in the crypto market, however, the main feature that distinguishes one from the other is the model through which they maintain parity with the US dollar. That is, its mechanism of backing or collateralization. 

These are the most popular ones: 

Collateral in fiat currencies or fiat assets:

Stablecoins backed with fiat money are those in which the collateral is US dollars in cash, bank deposits, US Treasury Bonds, commercial papers, certificates of deposit or other. 

This kind of stablecoin is centralized since whoever owns the collateral is the only issuer. The centralized quality of the collateral makes this type of stablecoin prone to various risks such as expropriation, bankruptcy of the financial institution that holds the collateral, insolvency of instruments that support them, and regulations.  

Collateral in cryptocurrencies: 

Cryptocurrency backed stablecoins are those in which the collateral are other crypto assets, in spite of being pegged to the price of a fiat currency such as the US dollar. 

This kind of stablecoin is distinguished by not having a physical collateral to hold custody of or manage, instead they are backed by cryptocurrencies and operate with smart contracts.  

Even though, according to the technical definition of cryptocurrencies, these digital assets are decentralized the premise of decentralization is not fulfilled in many of the networks that host alternative cryptocurrencies to bitcoin (altcoins). So while crypto-collateralized stablecoins should enjoy the benefits of decentralization, there are crypto-backed stablecoins collateralized with centralized cryptocurrencies.  

This is the main reason why you need to be very careful when investigating: the fact that a stablecoin is collateralized with cryptocurrencies does not mean that the model automatically brings decentralization. In fact, every protocol inherits the qualities of its collateral. If the collateral is centralized, it will follow that direction, while a decentralized collateral will opt towards the decentralization. 

Likewise, each crypto-collateralized stablecoin will be as robust and decentralized as its collateral. But bear in mind that if the collateral is provided by a single actor, the protocol will not be fully decentralized even when having a decentralized collateral.  

Collateral in bitcoin: 

Crypto-collateralized stablecoin protocols will only be as robust as their technology and collateral. So, with bitcoin being the first and best digital asset in existence, creating a stablecoin backed with bitcoin -digital gold-seems to be the best way forward. This was the idea that drove the creation of the Money On Chain stablecoin protocol. 

Algorithmic: 

As funny as it may sound, there is a kind of stablecoin that, in its purest form, does not use any kind of collateral. Instead, they employ algorithms and smart contracts that respond to predetermined rules and instructions that must be followed to obtain a certain result. In its best possible scenario, the result is a stablecoin that follows the value of the established asset 1:1, for example, the American dollar. However, as they have evolved, they have implemented hybrid systems that combine algorithms and collateralization.  

How do they intend to achieve the 1:1 peg? Algorithms are designed to incentivize certain behaviors among market participants and/or manipulate the circulation supply as a means to stabilize the price of the stablecoin. As good as this sounds in theory, in execution it has had catastrophic consequences. 

In addition to supply manipulation, another existing model for algorithmic stablecoins is a fractional algorithmic system. In this case, the model has: 

  1. A multi-currency system where the price of one of the digital currencies is designed to be stable and at least another digital currency is designed to enable stability. These conditions are planned to be achieved by the application of a combination of free market mechanisms that incentivize market participants to buy or sell the non-stable coin and, at the same time, employing mint and burn mechanisms for the stablecoin. 
  2. Only a fraction is collateralized. Theoretically, algorithmic stablecoins are more decentralized and independent because of their automated nature. However, on the one hand, as we mentioned earlier, a stablecoin is only as robust as its collateral, and on the other hand, algorithms that execute the mint/burn of coins have proven to fail as a mechanism to provide stability to algorithmic stablecoins. 

 Stablecoins use cases: 

  • Trading

From the very beginning, traders have been stablecoin users. Currently, stablecoins are widely used to buy/sell other cryptocurrencies in centralized (CEX) or decentralized (DEX) exchanges. 

Stablecoins are extensively accepted in crypto exchanges, which makes it a friendly alternative to deposit and withdraw from them. 

  • Payments

Since stablecoins function as the digital representation of dollars or euros, stable cryptocurrencies play an important role as a means of payment in everyday life, such as online shopping or service/product payments. 

Because they are accessible to everyone, low cost and stable means of payment, stablecoins have become an appealing payment method.  

  • Decentralized Finance (DeFi)

Stablecoins are widely used as collateral for loans, staking and other financial operations that generate returns for those who operate in the DeFi sphere, an acronym for decentralized finance. 

Decentralized finance follows the bitcoin path regarding decentralization: the elimination of a trusted third party, decentralized transactions that can be executed 24/7 and direct interaction with smart contracts.  

Store of value: 

In certain economies, such as the Argentinian, Venezuelan or Zimbabwean, stablecoins are used to protect the value of people’s savings from the inflation -or hyperinflation- of their local fiat currencies. At the same time, they are widely used as protection against volatility of other crypto currencies by global users. This is only possible due to its stable value anchored to widely used currencies such as the US dollar or the euro. 

Moreover, stablecoins are more easily accessible than traditional currencies such as fiat dollars in countries in Latin America, Asia and Africa, making them a striking alternative for those who want to save in dollars without the limitations imposed by government regulations. 

In other words, crypto stablecoins have become a synthetic digital dollar that anyone can hold in noncustodial wallets. 

Why are stablecoins important?

Bitcoin was created with the purpose of being neutral, immutable and censorship resistant money, which any government or corporate entity could control or censor. However, bitcoin is a naturally volatile asset, and there is a lot of debate about whether at some point in history it will cease to be so. 

While it still remains to be discovered whether it will have a less volatile price or continue the actual tendency, the whole world has started to understand the advantages of Satoshi’s invention: 

  • Digital money that cannot be diluted, programmed to be scarce. (21M) 
  • Neutral money, that works with a network of incentives and where users are pseudonyms. 
  • Decentralized money, where consensus among the majority of users and participants is required to make any changes. 
  • Cost-efficient money, designed to eliminate the additional costs of intermediaries. 

Bitcoin has proven to humanity that sound money is possible. 

Unfortunately, not everyone in the world has the privilege of being able to expose their savings to the volatility of bitcoin, and that is where stablecoins come in handy. 

As mentioned before, there are different kinds of stablecoins, but they all serve the same group of people: 

  • Those who live with exchange restrictions and want to access a better kind of money. 
  • Those who do not have the financial privilege to put part of their savings in bitcoin.
  • Those who want to avoid the high costs of traditional financial transactions. 
  • Those who are excluded from the banking systems in their home countries, and this list could continue. 

Stablecoins exist and are important because millions of people need access to the benefits of bitcoin but cannot afford its volatility. 

Thus, while Bitcoin was created to be the world's store of value because it is the neutral, decentralized and programmed money that free individuals of the digital world need, stablecoins were created to combat bitcoin’s volatility and translate the greatest number of bitcoin attributes to a stable currency

A bitcoin backed stablecoin?

Bitcoin is the existing cryptocurrency with the highest liquidity, largest number of users, the highest level of security and decentralization and, as rare as it may sound, the least volatile among all other cryptocurrencies. 

So, if you think that bitcoin is the best store of value, you will agree that it is the best collateral for a decentralized stablecoin. Hence, having a stablecoin that inherits bitcoin’s attributes of censorship resistance, decentralization, impossibility of expropriation, neutrality and trust minimization is what brings those that use stablecoins closer to good money. This vision was the engine that drove the creation of the Money On Chain stablecoin protocol. 

Money On Chain (MOC) is the stablecoin protocol that issues Dollar On Chain (DOC), a crypto stable currency 100% backed with bitcoin, whose collateral is provided for other participants. 

imagenes protocolo de stablecoin 2 02 1

In MOC’s case, the collateral providers are bitcoiners that bet on bitcoin-based economies in the long term, and therefore provide liquidity in exchange for benefits. 

Why use Money On Chain’s DOC instead of other stablecoins? 

Stablecoins have become a means of payment and saving for millions of people, so it is important that users deeply understand how the protocols that issue them work. 

The MOC model works with 4 tokens: a 100% backed with bitcoin stablecoin (DOC), a liquidity token that enables the minting of the stablecoin while receiving a small free leverage (BPRO), a leveraged long position on bitcoin that absorbs the volatility (BTCX) and a governance token, (MOC token). 

Let's explore the 3 main reasons why MOC model is different from other stablecoin protocols: 

  1. Collateral separated from issuance: 

In the Money On Chain model, the one who issues Dollar on Chain is not the one who brings the collateral as it usually happens in centralized models with fiat collateral. This enables anyone to mint their own DOC. 

It is important to note that this model allows the decentralization of the collateral but limits the creation of new DOC. This means that the maximum amount of DOC issued depends on the collateral brought by the other participants of the system, the liquidity providers known as BPRO holders. 

BPRO is a token that brings a series of incentives to bitcoin holders that decide to enable the creation of DOC by providing smart bitcoin (RBTC) to the Money On Chain protocol without giving up control of their private keys. 

In other words, the BPRO token is the liquidity token in the MOC stablecoin protocol, and it is often acquired by bitcoiners that believe that in the long term bitcoin will have a higher price than the dollar. Learn more about how BPRO has achieved +20% on top of bitcoin here. 

Money On Chain has proven its robustness even at the most averse market situations such as the bitcoin flash crash that took place in March 2020. This is due to its overcollateralization expressed in its global and target coverage. 

imagenes protocolo de stablecoin english 1
If you want to learn more about the non-liquidation feature of the MOC stablecoin protocol check this article in our blog. 

The Protocol’s health, that is to say, its global coverage, is public information available at all times in the platform metrics section. There you will also be able to see the amount of DOC available for minting and redeeming

Minting is the equivalent of issuing new DOC units using the collateral available in the protocol, which is provided by those executing the DOC minting operation and by those providing the liquidity, BPRO hodlers.  

Redeem means that you can convert DOC back into its collateral, a very rare feature in stablecoin protocols. Minting and redeeming are not synonyms of buying and selling, here we leave an article from our blog that will help you deepen your understanding of these concepts. 

So, how does the Money On Chain model work? 

To summarize, when there is a sufficient amount of smart bitcoins (RBTC) locked in the protocol, there is liquidity. This liquidity enables the minting of Dollar On Chain, a stablecoin pegged 1:1 to the US dollar. The RBTC that have been converted into DOC give up a part of the volatility to the BTCX and another part to the BPRO. 

Thus, as an interdependent three party system, is how the MOC stablecoin protocol ensures that 1 DOC is always equivalent to 1 USD. 

imagenes protocolo de stablecoin 2 04 1
  1. Self-contained on the blockchain 

As we have outlined through this article, the MOC stablecoin protocol model works as an interdependencies system and a balance of incentives among 4 participants: 

  • those who want a stablecoin (DOC) 
  • those who want a passive income in bitcoin (BPRO) 
  • those who want a long leveraged position (BTCX) 
  • and those who want to participate in the protocol’s governance, thus taking care of their interests (MOC).  

These 4 tokens make up a self-contained protocol on the blockchain. Behind the shiny words, this means that: 

  • There is no centralized issuer, every individual can issue their own stable money.
  • No confiscation risk, because bitcoin is the only collateral. 
  • Accessible to all humankind, as long as they count with internet access and a device in which they can keep their funds. 
  • Decentralized governance, which gives decision power to those who possess the MOC token. 

Curious about how governance in the MOC stablecoin protocol works? Click here. 

Money On Chain, a stablecoin protocol with bitcoin’s features

Stablecoins have become useful in everyday lives of millions of people around the world for being a sound alternative to bad money. In that sense, stablecoins need to be as robust as possible to be truly useful for people, because the goal is not to create yet another cryptocurrency but to bring a real solution with the attributes of sound money. 

Money On Chain takes bitcoin’s main qualities: robustness, decentralization, antifragility and builds a stablecoin with this purpose. A stablecoin backed in bitcoin, with decentralized collateral and self-contained in Bitcoin’s side chain, Rootstock. 

Learn more about MOC stablecoin protocol at your own pace! 

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