Stablecoins
Stablecoins are crucial to DeFi, because they separate the risk/return calculus of the DeFi services from the often high volatility of digital assets. Financial interoperability requires stable prices for value exchange and investors expect a steady unit of account for financial services.
Broadly, stablecoins can be organized into three categories:
Custodial or centralized stablecoins such as UDSC or Facebook's proposed Diem use holdings of fiat currency or high-quality liquid assets as a reserve. Because they require trust in the custodian, they are not DeFi instruments. However, they are included here because they may be incorporated into other DeFi services.
Asset-backed stablecoins use smart contracts to assemble and liquidate collateral in the form of cryptocurrencies or other assets.
Algorithmic stablecoins attempt to maintain the peg through dynamic expansion and contraction of token supply.
Because they operate on a non-custodial, decentralized, trust-minimized basis, asset-backed and algorithmic stablecoins are DeFi services themselves. As with the other areas of DeFi, projects are experimenting with different mechanisms. How effective each will be in maintaining its peg at scale and through different markets conditions remains the source of uncertainity.
