Crypto-backed stablecoin

Instead of handing dollars to a company, a user deposits assets such as ether or wrapped bitcoin into a smart contract and borrows newly minted stablecoins against them. The contract requires overcollateralisation, for example 150 dollars of collateral for every 100 dollars of stablecoins, and charges a stability fee. To recover the collateral, the user repays the stablecoins, which are then burned.

DAI, launched by MakerDAO in 2017, is the best-known example, and Liquity's LUSD and several newer designs follow the same principle. These tokens matter because they can be issued without a bank account or an issuer's approval, and every position is visible on-chain, which made them a core building block of early DeFi.

The weak point is volatile collateral. If prices fall fast, under-collateralised positions are liquidated at auction, and if liquidations fail during a crash the system can end up with bad debt. Many such stablecoins now hold large shares of fiat-backed coins or tokenised Treasuries as reserves, which makes them more stable but less independent of traditional finance.