**Asset-backed stablecoins** are the product of onchain loans. They mimic how banks create new money through lending. Decentralized overcollateralized lending protocols like the Sky Protocol (formerly MakerDAO) issue new stablecoins that are backed by onchain, highly liquid collateral. To understand how this works, consider a checking account. The money in your checking account is part of a complicated system of lending, regulation, and risk management that creates new money. In fact, the majority of the money in circulation, [the so-called M2 money supply](https://en.wikipedia.org/wiki/Money_supply), is created by banks through lending. While banks use mortgages, auto loans, business loans, inventory financing, and more to create money, lending protocols use onchain tokens as loan collateral thereby creating asset-backed stablecoins. The system that enables loans to create new money is called **fractional reserve banking**, which started in earnest with the Federal Reserve Banking Act of 1913. Fractional reserve banking has matured significantly since then with major updates in 1933 (with the establishment of the FDIC), in 1971 (when President Nixon ended the gold standard), and in 2020 (when reserve requirement ratios were reduced to zero).  With each change consumers and regulators became more confident in the systems that create new money through lending. Over 110 years, lending has created a larger and larger portion, now a larger majority, of the U.S. money supply. There’s a good reason consumers don’t consider all this lending every time they use a dollar. First, money stored in bank deposits is protected by federal deposit insurance. Second, despite major crises like those in 1929 and 2008, banks and regulators have steadily improved their practices and processes to reduce risk. Traditional financial institutions have used three methods to safely issue a loan: 1. against an asset with liquid markets and quick liquidation practices (margin loans) 2. using large scale statistical analysis over a bundled set of loans (mortgages) 3. with thoughtful and bespoke underwriting (business loans) Decentralized lending protocols still only make up a small portion of the stablecoin supply because they are at the very beginning of this journey.  The most prominent decentralized overcollateralized lending protocols are transparent, well tested, and conservative. For example, Sky, the most prominent collateralized lending protocol, issues asset-backed stablecoins against assets that are: onchain, exogenous, low volatility, and highly liquid (easily sellable). Sky also has strict rules about collateralization ratios as well as effective governance and auction protocols. These properties make sure that even with changing conditions, collateral can be safely sold, protecting the redemption value of the asset-backed stablecoin. Users can evaluate collateralized lending protocols against four criteria: 1. transparency of governance 2. ratio, quality, and volatility of assets backing the stablecoin 3. security of smart contracts 4. ability to maintain loan collateralization ratio in real time As with the example of money in a checking account, asset-backed stablecoins are new money created through asset-backed loans, but with vastly more transparent, auditable, and understandable lending practices. Users can audit the collateral underlying asset-backed stablecoins, but can only trust bank executives’ investment decisions with their deposits.  Further, the decentralization and transparency that blockchains enable can mitigate the risks that securities laws are intended to address. This is important for stablecoins because it means that truly decentralized asset-backed stablecoins are potentially [outside the scope of securities laws](https://www.fintechanddigitalassets.com/2022/01/the-limits-of-applying-reves-v-ernst-young-to-defi-and-the-perils-of-regulating-web3-by-enforcement/) — an analysis that may be limited to asset-backed stablecoins that rely exclusively on digitally native collateral (as opposed to “real-world assets”). This is because such collateral can be safeguarded with autonomous protocols, as opposed to centralized intermediaries. As more of the economy moves onchain, expect two things: first, for more assets to be candidates for the collateral used in lending protocols; and second, for asset-backed stablecoins to be a larger portion of onchain money. Other types of loans will likely eventually be safely issued onchain to further extend the onchain money supply. With that said, just because users can evaluate asset-backed stablecoins does not mean every user will want to take on that responsibility.  Just as it has taken time for traditional bank lending to grow, regulators to lower reserve requirements, and lending practices to mature, it will take time for onchain lending protocols to mature. So it will be a while before more people can easily transact with asset-backed stablecoins as readily as we can transact with fiat-backed stablecoins.