What is Fractional Stablecoin?
Let's find out Fractional Stablecoin meaning, definition in crypto, what is Fractional Stablecoin, and all other detailed facts.
Fractional stablecoin is a type of cryptocurrency that is collaterally backed and algorithmically stabilized. Fractional stablecoin protocols may vary in their options for collateral backing, with some using liquidity or partially allowing redemptions. However, the main principle is that the protocol never has more value to redeem than all the stablecoins that it mints.
Stablecoins are blockchain-based digital assets that have their price value pegged to a tangible asset, such as fiat currency or gold. Some stablecoins, like Tether (USDT), have the value of one coin pegged to $1.
Stablecoins must have a collateral, which means they have to be backed by fiat cash, other cryptocurrencies, or blockchain-based tokens to ensure their legitimacy.
Fractional stablecoins are backed in two ways. They are collaterally backed and algorithmically stabilized or modified. The collateralization ratio of fractional stablecoins is less than or equal to 100%. This means that the stablecoin is backed by a fraction of collateral compared to its overall worth.
The use of fractional stablecoins can improve capital efficiency since they do not require as many dollars as collateral. The overall supply of fractional stablecoins is greater than their liquidity or collateral backing. Fractional stablecoins are developed to include algorithmic mechanisms that stop bank runs via various economic incentives.
If the price of a fractional stablecoin goes above $1, algorithmic systems automatically create as many new stablecoins as needed until the price falls back down to $1. On the other end of the scale, if the price falls below $1 and the stablecoin is considered overcollateralized, the algorithm burns the excess coins.
Fractional stablecoins are preferred over algorithmic stablecoins because the latter can be hard to bootstrap, don’t grow as quickly, and are significantly more volatile. The volatility is a particularly significant downside as stablecoins aim to have low volatility by default.
Instead, fractional stablecoins only rely on algorithms that adjust the collateral and maintain the pegged value by either creating or burning the coins or tokens as necessary.