Stablecoin Divide: Fiat-Backed vs Crypto-Backed Stablecoins
The stablecoin market is divided into two main categories: fiat-backed and crypto-backed stablecoins. Fiat-backed stablecoins are backed by traditional assets such as cash, bank deposits, and short-term government securities, while crypto-backed stablecoins use other cryptocurrencies as collateral.
Fiat-backed stablecoins rely on an issuer's ability to issue and redeem tokens against reserves consisting of traditional financial assets. In contrast, crypto-backed stablecoins rely on collateral, smart contracts, incentives, liquidations, and market mechanisms to maintain their peg.
One key difference between the two types is overcollateralization. Crypto-backed systems often require users to deposit more collateral than the value of the stablecoins they create to mitigate the risk of collateral price volatility.