Asset-Backed Stablecoin

Concept

An asset-backed stablecoin (also, AB stablecoin) is a stablecoin backed by, and valued against, a certain type of assets. Examples of underlying assets include physical assets (such as gold and real estate), financial assets and equities (e.g., stocks or mutual fund shares). These assets are used to back this type of stablecoin and provide a level of stability in its price. However, as the set of assets that can be used may differ from one country to another, due to certain considerations (or lack of) in each country’s local laws and regulations.

The concept of asset-backed stablecoin is quite similar to that of crypto-backed stablecoins (which represent a subcategory or type of asset-backed stablecoins) that are characteristically backed (collateralized) by reserves of other cryptocurrencies (or cryptoassets). In essence, a stablecoin is a cryptocurrency (or a digital token) that derives its value from real-world assets (RWAs), such as commodities, precious metals, real estate, or other tangible assets, intangible assets or financial assets. It is a digital asset whose value is pegged to a reference asset, which is either fiat currency, exchange-traded commodities (such as precious metals or industrial metals), or another cryptocurrency. Stablecoins (also, asset-backed cryptocurrencies) are created by establishing a sort of link between the value of the digital token to the underlying asset using blockchain technology. The value of this asset-backed token (ABT) or backed crypto asset is referenced to the performance and market value of the asset it represents. The prices of crypto-backed stablecoins are pegged to a broad set of assets, not necessarily fiat currencies, and hence users can reasonably mitigate the effect of inflation or regulatory measures on performance of such coins. For example, since Bitcoin is a decentralized currency, its value does not correlate to that of fiat currencies like the dollar or euro. In times of high uncertainty, crypto-backed stablecoins may provide a better venue for market participants (for more, see: types of stablecoins).

Example

A prime example of asset-backed stablecoin is one pegged to the price of gold with a reference value of 1 gram of gold per 1 coin. The performance of the coin is determined based on the fundamentals of gold price in the global markets. The notion holds that the issuer of asset-backed stablecoins maintains asset reserves (which might also be fiat assets or digital asset reserves) as underlying of, and backing to, the value of each token. The creation process involves the application of the principle of overcollateralization in the event that the backing assets experience a degree of volatility time to time. Different types of stablecoins interact differently with the established banking sector and with applicable monetary policy, and hence regulatory strategies would also differ from country to another. By characterization, such coins are perceived as a digital bearer instrument that is transferred by the holder without the need for consent or involvement of the issuer. When a party receives a stablecoin, ownership automatically transfers along with the liability of the issuer.

Underlying principle

Like crypto-backed stablecoins, asset-backed stablecoins operate on the principle of overcollateralization — meaning that the value of assets held in reserves (that of the cryptoassets) exceeds the value of the pegged stablecoin. In this context, overcollateralization aims to mitigate the inherent volatility of the reserve assets (underlying assets). Users lock up their backing assets, on the blockchain, via a smart contract and receive an equivalent value in stablecoins that is usually lower than the value of backing assets. This means that if underlying assets go down in value, the value of the collateral will be less, and drives certain positions to default on payment. The additional amount of collateral can account for this adverse scenario, and if the value of the collateral drops even further, the protocol automatically liquidates a portion of the collateral to cover the stablecoin issued.