Is It Possible To Back A Stablecoin Against More Than One Commodity?
Cryptocurrencies are an attractive asset class but remain a puzzle to many. First, it was the complex technology behind the virtual coins, then the decentralized nature of the currency that scared even governments away from the digital assets. Finally, however, people with wits took on this innovation and saw it as an excellent opportunity for wealth accumulation.
However, one more thing came to light, crypto volatility. Cryptocurrencies are notoriously volatile, but this was not the end of the road for the enthusiastic crypto community. A new class of cryptocurrencies, Stablecoins, came up in an attempt to combat crypto volatility.
Stablecoins are cryptocurrencies that attempt to provide price stability in the crypto industry by backing crypto coins with a reserve asset. The reserve asset can be a fiat currency, another cryptocurrency, or a real-world commodity. Our concern in this piece is whether you can back a stablecoin with more than one commodity.
For insights into our concern, it’s good to have a deeper understanding of stablecoins and their various types. Generally, they fall into the categories of asset-backed and non-asset-backed stablecoins.
The premise here is that even though their prices are susceptible to volatility, they can never fall below the value of the asset backing it. The non-asset-backed stablecoins rely on a set of algorithms that control their price.
Fiat Currency-Backed Stablecoins
Fiat-backed stablecoins are crypto coins collateralized to a fiat currency such as the US dollar, the Euro, or Yen. They have a central issuer who maintains the reserve fiat currency of a proportionate amount to the stablecoins issued. Thus, the backing of the stablecoin is at a 1:1 ratio between the token and the fiat backing.
If the issuers maintain a reserve of 10 million USD, they will issue an equivalent number of tokens worth a dollar each. In most cases, the reserves remain under independent custodians and get audited regularly for compliance.
Stablecoin holders can trade at any time and receive their US dollar worth. In this model, backing a stablecoin with two commodities would mean pegging the token to two or more fiat currencies, which is practically impossible. Different fiat currencies have varying values and may fluctuate at different times and in different directions.
As such, it would be challenging to determine where the actual value of the stablecoin lies. Besides, the general principle behind fiat currency backing is the 1:1 reserve ratio between the stablecoin and the associated fiat currency.
Cryptocurrency-backed stablecoins are not much different from fiat-backed coins. The only significant difference is that the coins get pegged to another cryptocurrency rather than fiat currency. In addition, the type of stablecoins considers the volatility of the underlying asset, so the reserve ratio is not 1:1.
For instance, if the stablecoins issued have a market value of 20,000 USD and are backed by ETH, then an equivalent of 40,000 USD in ETH can be used as the reserve. Thus, cryptocurrency-backed stablecoins create the possibility of backing a coin against more than one asset.
The 40,000 USD in ETH can get split into two or more cryptocurrencies worth the required 40,000 USD reserves. For example, the reserve could constitute 20,000 USD in ETH and 20,000 USD in BTC. The amount of each cryptocurrency issued to back the stablecoin can vary depending on the volatility of the different crypto coins.
Real World Asset-Backed Stablecoins
Commodity-backed stablecoins are crypto coins pegged to real-world assets like real estate, oil, and precious metals such as gold and silver. Due to its stability in value, gold is the most popular tangible asset backing stablecoins such as Paxos Gold (PAXG). Each PAXG stablecoin usually represents one ounce of gold. In essence, this is similar to the 1:1 reserve ratio principle, although the assets are divisible.
For instance, if one stablecoin is equivalent to an ounce of gold, then half the value of an ounce of gold can be used to acquire the gallons of oil it is worth. The stablecoin can then get pegged with half an ounce of gold and its equivalent number of gallons of oil. The coin would still be redeemable for the assets, an ounce of gold, or the gallons of oil equivalent to the price of an ounce of gold.
Although many stablecoins pegged to different assets exist already, the idea is yet to get fully explored. Stablecoins backed by gold, fiat, cryptocurrencies, and oil hit the headlines in the past, but the industry still lacks active projects with more than one commodity backing.
Fiat-currency backing poses the most significant challenge in multiple stablecoin backing due to the centralization of currencies and sharp differences in value. Cryptocurrencies would probably be the best assets to peg a stablecoin and maintain different coins in reserve. Each cryptocurrency has its USD equivalent value which can form the base for determining the amount of each crypto coin to hold in reserve.
However, the model would still be heavily dependent on fiat currency. For real-world assets, coins could be pegged to commodities like gold and oil and still use fiat as the base for determining required proportions. However, the same would be difficult for unquantifiable assets like real estate.