Smart contract blockchain Cardano is currently working on introducing two new stablecoins, both of which aim to deliver greater stability to stablecoins. The Cardano development team will roll out the first fully-regulated, fiat-backed, USD-pegged $USDA stablecoin alongside an over-collateralized algorithmic stablecoin issued by COTI titled $DJED in 2023.
Stablecoins, originally designed to act as a solution against the volatility of cryptocurrencies, have come under intense scrutiny of late. At the heart of the issues are concerns about the working principles of stablecoins, especially fiat-backed and algorithmic stablecoins.
Back in March, Terra’s algorithmic stablecoin TerraUSD (UST) experienced a complete meltdown, highlighting the shortcomings that led to a wipeout, the aftereffects of which are still swirling. Since then, several other stablecoins have briefly lost their fiat pegs, underscoring the issues like regulatory loopholes and lacking stablecoin reserve transparency.
A Fully-Regulated, Fiat-Backed Stablecoin
Ideally, fiat-backed stablecoins are pegged at a 1:1 ratio with fiat currencies, primarily the United States Dollar (USD) or Euro. Some stablecoins rely on over-collateralization to maintain their pegs, meaning backing by more assets than the total value of the stablecoin issued. The matter of reserves, however, remains a contentious issue, especially among the biggest fiat-backed stablecoins like Tether (USDT) and USD Coin (USDC) that centralized players issue.
The problem here is that unlike the claims made about reserves, most reserves for these stablecoins are a complex mix of commercial papers, secured loans, corporate bonds, precious metals, and other similar assets. Moreover, these issuers don’t fall under the purview of regulatory authorities, complicating the counterparty risks for investors.
Unlike peers, Cardano’s forthcoming $USDA will be a fully-regulated stablecoin. Developed by Cardano’s founding entity Emurgo, $USDA is a USD-pegged stablecoin that will anchor lending and borrowing, crypto-backed card payments, and bridges connecting traditional finance (TradFi) and decentralized finance (DeFi) within the Cardano blockchain ecosystem.
To ensure it complies with oversight rules, Emurgo has partnered with a regulated U.S.-based financial services company that will act as the banking partner responsible for issuing $USDA tokens.
The $USDA token is slated for introduction on the Anzens platform in 2023, helping users convert U.S. dollars into $USDA with credit and debit cards, wire transfers, and even with other stablecoins like USDC and USDT, as well as with Cardano’s $ADA token. Following the launch, the platform intends to expand its conversion and swap services to other cryptocurrencies like Bitcoin (BTC-USD) and Ethereum (ETH-USD).
An Over-Collateralized Algorithmic Stablecoin
Compared to fiat-backed stablecoin peers, algorithmic stablecoins rely on predefined rules (algorithms) to automatically balance the demand and supply. This means that the value of an algorithmic stablecoin will fall below its peg if the amount of tokens in circulation outstrips demand.
When supply exceeds demand, smart contracts execute transactions to remove excess stablecoins from the circulating supply and, in turn, create new units of the pegged token. In UST’s case, the algorithm created new LUNA tokens since UST had a 1:1 peg with LUNA, which is a speculative asset in itself.
Unlike fiat-backed stablecoins, algorithmic stablecoins like TerraUSD (UST) don’t have any reserves or collateral backing their issuance. They are backed by nothing more than a set of algorithms. For instance, the entire idea of UST maintaining its peg to the U.S. Dollar relied on a computer program designed to maintain the equilibrium between supply and demand.
COTI addresses non-collateralized stablecoins through its upcoming over-collateralized algorithmic stablecoin $DJED, which is backed by Cardano’s native $ADA token and the reserve currency $SHEN. COTI is a layer-1 blockchain payment network designed for high speed and security, achieving a throughput of up to 100,000 transactions per second (TPS) through its Proof-of-Trust consensus mechanism. Additionally, COTI delivers the infrastructure needed to create and issue stablecoins featuring high security and scalability alongside low transaction fees.
Although this model can be vulnerable if $ADA experiences a sudden downturn like what unfolded with LUNA, the underlying smart contracts include a reserve currency called $SHEN. In the event of $ADA volatility, $SHEN will be used to balance the fluctuations in the price, helping provide over-collateralization rates of 400% to 800%.
After completing a series of audits and stress tests, $DJED is scheduled to go live on the mainnet in January 2023. Following its release, $DJED will be integrated with selected decentralized exchanges (DEXs) and partners.
Conclusion: Cardano Looking to Address Stablecoin Shortfalls
Where other stablecoin initiatives have fallen short, whether the result of de-pegging, lacking transparency and regulatory compliance, or over-reliance on algorithms, Cardano’s stablecoin strategy approaches these concerns head-on. Properly addressing these realities can unlock more stability for the broader ecosystem and restore trust, improving confidence while acting as a dependable conduit between TradFi and DeFi that can overcome recurring liquidity shortages.