A digital token that is collateralized or backed by other cryptocurrencies. These tokens represent a subset of asset-referenced tokens (asset-backed tokens) which have their value linked to other cryptoassets. This involves the deployment of technology whereby value is transferred, stored or traded electronically on a decentralized system using cryptography, and not any central bank or similar market authorities.

Asset-referenced tokens are created to maintain a stable value by establishing a link with certain types of currencies that are legal tender (typically known as fiat-currency), tradable commodities, other certain types of cryptoassets or a basket of such assets.

A prime example is a crypto backed stablecoin (stablecoin) that functions basically the same way the fiat-backed stablecoins functions. Crypto backed tokens use the security of underlying cryptocurrencies (the so-called security pledge) to mitigate the volatility of the cryptocurrency which is being used as collateral. However, instead of using fiat-denominated assets as collateral, these tokens have cryptocurrencies posted as collateral. A crypto-backed token usually depends on an overcollateralized reserve to account for the volatility of the underlying cryptocurrencies used as collateral. In other words, for a dollar-backed token, each one dollar token is typically collateralized by an amount exceeding one dollar.

Being on-chain assets, crypto-backed tokens (and crypto-backed stablecoins) don’t require either custodians or external third parties to regulate their functioning, as the reserve values can be publicly verified in real time. The stability mechanism does not compare, however, to that of fiat-backed stablecoins, particularly due the nature of the collateral locked up in cryptocurrencies which exhibits higher levels of fluctuations and lower predictability. Contrary to crypto-backed tokens, fiat-backed tokens have their prices pegged to the value of a particular fiat currency. Most of these tokens are backed by a promise extended by the stablecoin issuer that one fiat-backed stablecoin can be exchanged for one unit of fiat at the time of need.