Crypto-backed stablecoin
Also called: crypto-collateralized stablecoin · overcollateralized stablecoin
Definition
A crypto-backed stablecoin is a stablecoin issued against crypto collateral locked in smart contracts, usually worth more than the coins created, so the token can stay near 1 USD.
This entry is shown in English.
How Crypto-backed stablecoin works
Instead of keeping dollars in a bank, a crypto-backed stablecoin is minted by users who deposit assets like ETH into a smart contract. DAI, originally created by MakerDAO (now Sky), is the best-known example. Because crypto prices swing, the system demands overcollateralization: you must lock more value than you borrow.
Each vault has a minimum collateral ratio. If the collateral value falls too close to that line, the vault is liquidated: the collateral is sold or auctioned to repay the stablecoin debt, and the owner usually pays a penalty. This mechanism is what keeps the coin backed.
The upside is transparency: anyone can check collateral on-chain. The risks are sharp market crashes, oracle failures that feed wrong prices, and smart contract bugs. Some designs also hold other stablecoins or tokenized real-world assets as part of their backing, which brings in off-chain risk.
Example
Suppose ETH trades at 3,000 USD and you deposit 2 ETH, worth 6,000 USD, into a vault with a 150% minimum collateral ratio. You mint 3,000 stablecoins, giving you a ratio of 200%. If ETH drops to 2,250 USD, your collateral is worth 4,500 USD and your ratio is exactly 150%, so the vault can be liquidated. To stay safe, you could repay part of the 3,000 debt or add more ETH before the price reaches that level.
Common mistakes
- Minting the maximum amount allowed so that a small price drop triggers liquidation.
- Assuming crypto-backed means fully decentralized, without checking whether part of the reserves are centralized stablecoins or real-world assets.
- Forgetting that stability fees or borrow rates accrue on the debt over time.
Learn and practise
FAQ
Is DAI a crypto-backed stablecoin?
Yes, DAI is minted against collateral locked in smart contracts. Over time its backing has expanded beyond ETH to include other stablecoins and tokenized real-world assets.
Why do crypto-backed stablecoins need overcollateralization?
Crypto prices can fall quickly. Locking more value than the stablecoins issued gives the system a buffer to liquidate collateral before the debt becomes undercollateralized.