Crypto-Backed Stablecoin

A crypto-backed stablecoin is a stablecoin that maintains its peg using other cryptocurrencies as collateral, locked in smart contracts rather than held by a company. Because the collateral itself is volatile, these systems require overcollateralization: users must deposit more value than they borrow, giving the system a buffer against price drops.

DAI is the best-known example. A user can lock, say, 150 dollars' worth of Ether in a vault and mint 100 DAI against it. If the value of the Ether falls too close to the debt, the position is automatically liquidated — the collateral is sold to keep the system solvent. This mechanism, plus incentives that encourage minting or repaying DAI as its price drifts, keeps the token near one dollar without a central issuer holding bank reserves.

The appeal is transparency and censorship resistance: collateral is visible on-chain and no single company controls redemptions. The costs are capital inefficiency (locking 150 dollars to get 100) and exposure to crashes in the collateral, which in extreme market moves can cause liquidation cascades. A common misconception is that crypto-backed means uncollateralized or algorithmic; in fact these systems typically hold more collateral per token than fiat-backed ones, just in a riskier asset.