Unpacking Cardano’s $DJED: What You Need to Know

Stablecoins are a unique category of digital asset known for their stable value, often tied to real-world assets like fiat currencies or gold.

They were primarily designed to offer stability and facilitate access to the volatile cryptocurrency market by enabling investors to seamlessly convert their crypto assets into traditional fiat currency and vice versa on exchanges.

There are several types of stablecoins in use today, including:

Algorithmic Stablecoins: These stablecoins rely on smart contracts and algorithms to maintain a stable value.
Fiat-Backed Stablecoins: Backed by physical fiat currencies held in reserve, these stablecoins aim to maintain a one-to-one peg with the underlying fiat currency.
Commodity-Backed Stablecoins: These stablecoins derive their stability from tangible assets like gold, grounding their value in the intrinsic worth of these commodities.
Crypto-Backed Stablecoins: These stablecoins use other cryptocurrencies as collateral to maintain their stability, typically overcollateralized to prevent price fluctuations.

Cardano’s DJED is an algorithmic stablecoin developed through a partnership between blockchain company Coti and Input Output, the core developer behind the Cardano project.

DJED has generated significant traction since its launch amidst ongoing debates surrounding the potential of stablecoins to replace fiat currencies, the emergence of Central Bank Digital Currencies (CBDCs) as competitors, the regulatory challenges faced by stablecoin issuers, and the security and transparency of stablecoins.

This article comprehensively explores Cardano’s DJED stablecoin, explains how it works, and examines its potential use cases and impact on the Cardano ecosystem.

What is DJED?

DJED, an algorithmic stablecoin pegged to the US dollar, was introduced at the 2021 Cardano Summit and is a collaborative effort between COTI and Input Output Hong Kong (IOHK).

DJED was designed to become the primary currency for covering transaction fees on the Cardano network. This will ensure consistent and predictable transaction costs, making it highly likely that DJED will be integrated into all Cardano network applications.

Think of DJED as a decentralized bank. It is over-collateralized and backed by two tokens (ADA; Cardano’s native token, and SHEN). Both of these tokens serve as DJED’s reserves, guaranteeing its price stability and its peg to the US dollar.

The Role of COTI1

COTI is the world’s first platform dedicated to developing price-stable coins. DJED’s front-end activities will be handled entirely by the company. In return, COTI will receive fees generated from the minting and burning of DJED and its reserve coins as compensation for their services.

Why is DJED Classified as an Algorithmic Stablecoin?

Unlike stablecoins directly backed by fiat currencies like the US dollar on a 1:1 basis, algorithmic stablecoins, like DJED, employ a unique approach to maintain their stability.

Tether (USDT), the most popular fiat-backed stablecoin; has drawn criticism due to concerns over insufficient reserves.

Algorithmic stablecoins like DJED operate differently to solve this problem. Instead of relying on external assets, they depend on a built-in algorithm to keep their value stable. This algorithm continuously adjusts the coin supply based on changes in the coin’s price.

When the coin’s price goes up, more coins are issued; when it goes down, the system buys more coins to boost the price. To maintain stability, the system also keeps a reserve of base coins. This innovative approach allows DJED to maintain its value without being directly tied to traditional currency reserves.

Why Cardano Needs a Stablecoin

Initially, DJED will serve the purpose of covering transaction fees within the Cardano network. However, in the near future, Cardano will require this stablecoin for more significant transactions, particularly in decentralized finance (DeFi).

Despite the Cardano DeFi ecosystem having attracted less than $60 million in investments, it has surpassed expectations. DJED is expected to play a pivotal role in boosting adoption within the ecosystem.

So, What Exactly Does DJED Bring to the Cardano Network?

It’s important to note that COTI and IOG described DJED as the “first stablecoin protocol with precisely defined and mathematically proven stability claims.” As mentioned earlier, DJED will always maintain collateralization levels ranging from 400% to 800% to ensure stability.

To illustrate, DJED will function as a decentralized financial institution with various practical applications. COTI is actively developing DJED Pay, which will enable users to make payments to vendors using this stablecoin. Additionally, DJED will find utility in lending, alternative banking services, and remittances (more on this later).

The stablecoin is also expected to be widely integrated throughout the Cardano ecosystem. Several NFT marketplaces and DEXs are already working on integrating it.

One persistent challenge in the cryptocurrency world is the issue of gas fees. Every transaction incurs costs, and these fees tend to fluctuate depending on network conditions. As cryptocurrency prices surge, so do transaction costs. By leveraging a stablecoin like DJED to cover transaction fees, Cardano users can mitigate the unpredictability associated with gas fees.

How DJED Works: A Simple Explanation

DJED uses a smart contract to maintain its peg to the US dollar, and this contract is backed by ADA, Cardano’s native cryptocurrency.

Here’s how it works:

When users send ADA to the smart contract, they receive an equal amount of DJED in return. This builds a pool of ADA that safeguards the value of all circulating DJED tokens.
DJED holders can exchange 1 DJED for $1 worth of ADA by sending it back to the smart contract. The smart contract then burns the DJED tokens it receives to maintain DJED’s value at $1.

The cryptocurrency market can be unpredictable. If the value of ADA drops significantly, there might not be enough ADA in the contract to compensate DJED holders. TerraUSD (UST) faced this problem during LUNA’s crash in May 2022.

To ensure price stability, DJED has a unique approach. It uses a smart contract with a reserve of SHEN, the company’s designated reserve currency, backed by 400% to 800% collateral. This reserve safeguards DJED holders in case ADA’s value decreases, as they will receive SHEN as compensation.

There are specific rules: SHEN cannot be burned for ADA if the reserve ratio is below 400% or minted if it’s above 800%. DJED’s Proof-of-Reserve adds transparency and trustworthiness to the system, which is crucial in today’s market.

While DJED maintains a stable value tied to the US dollar, SHEN is more volatile and subject to market fluctuations. Holders of SHEN will receive compensation when they exchange ADA for DJED, SHEN, or vice versa.

Difference Between DJED and Terra’s UST

The primary purpose of stablecoins is to mitigate the volatility seen in cryptocurrencies. However, the UST crash in May 2022 was more than just an algorithmic stablecoin failure; it also triggered a series of disastrous events that unfolded later that year.

Undercollateralized algorithmic stablecoins are a ticking time bomb. In contrast, DJED is designed to maintain stability consistently by maintaining a collateralization rate of 400% to 800%.

Furthermore, the DJED contract has ample funds to repurchase all DJED stablecoins in circulation for $1 worth of the underlying asset, thereby ensuring the stability of its peg.

DJED operates autonomously and is fully backed by a substantial reserve ratio, guaranteeing overcollateralization. In contrast to Terra, which encountered a temporary network halt and necessitated manual management of its BTC reserves, DJED operations are not dependent on group decisions.

Potential Future Use Cases for DJED

International Payments

Many international payment networks are already considering the incorporation of algorithmic stablecoins into their platforms. DJED is a compelling alternative to existing payment systems due to its increased stability, low costs, quick transaction times, and enhanced security.

Decentralized Finance

DJED would significantly benefit the DeFi ecosystem, offering users a safer and more stable means of exchanging money, enabling them to trade in more dependable digital assets.

P2P Remittances

DJED offers a quick, cheap, and secure way of sending money, making it suitable for P2P (peer-to-peer) remittances. Due to the low transaction cost and speed, as well as the increased stability of algorithmic stablecoins, DJED is a viable alternative to existing cross-border payment systems.

Lending

Algorithmic stablecoins (like DJED) can be used in lending markets as an alternative to more volatile cryptocurrencies. DJED’s stability can aid lenders and borrowers in establishing more dependable loan agreements.

Insurance

Many insurance companies have already begun to investigate the use of algorithmic stablecoins to provide more reliable and stable insurance products. These companies can substantially benefit from the capability to instantly disburse claims in the form of a stablecoin without involving a banking intermediary.

Stablecoins Could Be in For a Bumpy Ride

Crypto investors must pay close attention to the regulatory landscape, particularly as concerns about stablecoins grow in Europe and the USA. Lawmakers are worried that stablecoins, unlike traditional banks, don’t adhere to the same rules, exposing investors to higher risks.

According to Bloomberg, the Treasury is set to unveil a framework for managing stablecoins. Additionally, SEC Chair Gary Gensler has repeatedly voiced his belief that many stablecoins are unregistered securities and should fall under SEC oversight.

Disclaimer: This article is intended solely for informational purposes and should not be considered trading or investment advice. Nothing herein should be construed as financial, legal, or tax advice. Trading or investing in cryptocurrencies carries a considerable risk of financial loss. Always conduct due diligence.

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