A fractional stablecoin is a type of cryptocurrency that is collaterally backed and algorithmically stabilized. Fractional stablecoin models may vary in collateral backing options, some by using partial liquidity backing, or partially allowing for redemption. However, the main principle is that a protocol is never worth more to redeem than all the stablecoins it mints.
Using fractional stablecoins can improve capital efficiency because they do not require as many dollars as collateral, as the total supply of fractional stablecoins is greater than their liquidity or collateral backing. Fractional stablecoins are developed in such a way that algorithmic mechanisms are involved in their operation.
If the price of a fractional stablecoin exceeds 1 USD, algorithmic systems will automatically create as many new stablecoins as necessary until the price falls back to 1 USD. On the other hand, if the price drops below 1 USD, the algorithm burns the excess coins.
Fractional stablecoins have gained an advantage and are preferred over algorithmic stablecoins, because the latter are usually significantly more volatile. A stablecoin needs to have minimal volatility, ideally leaving it consistently equal to a 1:1 ratio to the USD.
Fractional stablecoins have solved the problem of unstable, purely algorithmic stablecoins, which have failed by de-peg many times in the cryptocurrency world, causing financial losses to large numbers of users. Fractional stablecoins improve capital efficiency, as fewer dollars must remain idle as collateral. That means they have a greater circulating supply of tokens than liquidity or collateral, and use algorithmic mechanisms that prevent deposits from being depleted through economic incentives. They are currently gaining in popularity among users in the cryptocurrency world, and if they prove successful in the long run, we are looking at a bright future within DeFi, with high-quality, decentralized stablecoins.