Crypto-collateralized stablecoins are decentralized digital currencies backed by other cryptocurrencies (like ETH or BTC) locked in smart contracts, using over-collateralization to absorb volatility and maintain a stable value, with MakerDAO's DAI being the leading example, offering on-chain transparency but being vulnerable to the underlying crypto's price swings.
How They Work
Locking Crypto: Users deposit more valuable crypto (e.g., $1500 worth of ETH) into a smart contract vault to generate a smaller amount of stablecoins (e.g., $1000 worth of DAI).
Over-Collateralization: This excess collateral acts as a buffer, ensuring that even if the value of the locked crypto drops significantly, there's still enough backing to cover the issued stablecoins.
Liquidation: If the collateral's value falls too low, the system automatically liquidates some of it to repay the stablecoins and maintain the peg, preventing insolvency.
Decentralized Control: Unlike fiat-backed stablecoins, they rely on code and smart contracts, eliminating central banks or corporate intermediaries, with reserves verifiable on-chain.
Key Characteristics
Backing: Other cryptocurrencies (e.g., ETH, WBTC).
Mechanism: Smart contracts, over-collateralization, and automated liquidation.
Transparency: High, as reserves are visible on the blockchain.
Example: DAI (MakerDAO).
Risk: Volatility of the underlying crypto and potential smart contract bugs.
