Stable coins are simply cryptocurrencies with stable value, sharing all the appealing characteristics of other cryptocurrencies but without the volatility. They are often, but not always, pegged to a fiat currency like the US dollar. Broadly speaking, stable value cryptocurrencies can be grouped into three categories: fiat-collateralized, crypto collateralized, and seigniorage style.
Fiat-collateralized Stable coins.
Fiat-collateralized stable coins act as IOU tokens. These tokens are created when fiat currency is sent to a centralized party and destroyed when the centralized party returns that fiat to the token holder. Arbitrageurs play an important role in fiat-collateralized systems, purchasing and redeeming tokens when the market price is less than the value of the IOU, and creating and selling tokens when the market price is greater than the value of the IOU. This mechanism has the advantage of being simple and easy to understand. Theoretically, fiat-collateralized tokens will remain perfectly stable, as they can be easily redeemed for fiat. In practice, however, the redemption process can be slow and expensive. Furthermore, these tokens rely on a trusted centralized third party to hold the collateral, and regulation and regular audits are necessary in order to build and maintain that trust.
Crypto-collateralized Stable coins
Crypto-collateralized stable coins, on the other hand, are backed by cryptocurrencies rather than fiat. This is often done using loan instruments, where users can borrow stable coins by locking up other cryptocurrency holdings (e.g. ether) as collateral. These systems are more decentralized than the fiat-collateralized model, as the collateral is held by a smart contract rather than an off-chain entity. The liquidation process occurs entirely on-chain, resulting in faster redemption of the stable coin for the underlying collateral. Furthermore, crypto-collateralized stable coins are fully transparent; any user can audit the code or query the amount of collateral being held. Unfortunately, this approach can come at the expense of complexity and requires over-collateralization to absorb price fluctuations in the collateral.
Seigniorage-style Stable coins
Finally, seigniorage-style stable coins algorithmically expand or contract the supply of the stable token in order to match demand. These systems typically introduce one or more non-stable, or seigniorage, assets that may fluctuate in value in response to changes in demand for the stable coin. This will shift volatility risk from the coin holders to the complementary asset holders, depending on the activity of the market. These types of systems are arguably the most decentralized; as they don’t rely on any other crypto or fiat currency in order to maintain their stability. However, they can be complex to build and analyze and may be particularly vulnerable to a decline in market confidence around the seigniorage token or the cryptocurrency space as a whole.
Egoras Approach
The Egoras price stability protocol can be thought of as a hybrid cryptocollateralization/seigniorage-style model, designed in a way that we believe offers the best of all three approaches. The protocol supports an ecosystem of stable currencies, the first of which, the Egoras Dollar, will be pegged to the US Dollar. The native asset of the Egoras platform is Egoras Coin, which is used to expand and contract the supply of Egoras Dollars in response to changes in demand, thus serving as the seigniorage-style token. The protocol holds Egoras Coin in a reserve. In the initial implementation of the protocol, maintaining this asset allocation will be done in a transparent, systematic, but more manual fashion. The reserve ratio, also called the collateralization ratio, represents the size of the reserve with respect to the total value of all outstanding stable coins. Maintaining a high reserve ratio is critical to the stability of the system. the protocol levies a stability fee on the creation of Egoras Dollars.
Expansions and Contractions
The protocol uses the vault to adjust the supply of Egoras Dollars in response to changes in demand. It relies on a number of oracles external to the blockchain to provide feeds of the Egoras coin price in US Dollars. To maintain the peg, the protocol allows users to create new Egoras Dollars by sending $1 worth of Egoras coin to the vault, or to destroy Egoras Dollars by redeeming $1 worth of Egoras Coin from the vault. This is similar to how fiat-collateralized coins work, except that the trusted third party (e.g. Tether or Circle) is replaced by a decentralized protocol. When demand for the Egoras Dollar rises and the market price is above the $1 peg, arbitrageurs can profit by purchasing $1 worth of Egoras Coin, exchanging it with the protocol for one Egoras Dollar, and selling that Egoras Dollar for the market price, pocketing the difference. Similarly, when demand for the Egoras Dollar falls and the market price is below the peg, arbitrageurs can profit by purchasing a Egoras Dollar for the market price, exchanging it with the protocol for $1 worth of Egoras coin or basket of other cryptocurrencies, and selling the Egoras coin to the market. These actions drive the market price of the Egoras Dollar back towards $1. Additional mechanisms are needed to prevent the reserve from becoming overly depleted when the price of Egoras Coin supplied by the oracles does not match the market price. This can happen during times of high volatility or when the oracle system is compromised. Without these mechanisms, the protocol may offer to sell Egoras Coin at a large discount, or purchase it at a large premium, depleting the vault and weakening the protocol’s ability to absorb future contractions in demand for Egoras Dollars.
