Oh, sweet stability. What crypto holders would give for a little more of this from time to time. The highly speculative nature of the market leads to price volatility of cryptocurrencies, which can be extremely stressful for investors and crypto enthusiasts. Prices go up and down like crazy and the whole market is still strongly co-related to Bitcoin’s market performance. This crypto rollercoaster ride has created a need for a stable digital currency.
According to Forbes, an optimal cryptocurrency should posses the following characteristics: price stability, scalability, privacy and decentralization. They also dubbed stablecoins the holy grail of cryptocurrency. This is because due to their stability, stablecoins can bring cryptocurrencies into mainstream.
What is a Stablecoin?
A stablecoin is a cryptocurrency that is pegged to the value of an underlying asset. They are called stablecoins because the value of these cryptocurrencies are kept stable in relation to the underlying asset.
The value of a stablecoin thus relies on another asset that has already been given value. These assets can be fiat currencies, commodities such as gold, silver and oil, but also assets such as real estate. Preferably, the asset to which the stablecoin’s value is pegged to is relatively stable in value, but this is not a must.
Stablecoins leverage all the advantages of cryptocurrencies. They are cryptographically secured, easily and rapidly transferable between parties, and anyone with access to the internet can create a wallet and own these stablecoins.
However, stablecoins are not subject to the extreme price volatility that regular cryptocurrencies are affected by.
Where cryptocurrencies have a maximum limited supply that leads to major shifts in price with every change in demand, stablecoins are pegged to the value of an asset. This keeps the value of stablecoins relatively constant and makes these cryptocurrencies highly useful both a store of value and as a method of payment.
There are two types of stablecoins:
- Stablecoins that are backed by the asset it’s pegged to. These are legally-backed stablecoins. If ever something goes wrong, holders of this type of stablecoins are legally entitled to the underlying assets.
- Stablecoins that are kept stable in comparison to the price of the asset but do not represent ownership of the asset. This type of stablecoin is kept stable through ingenuous, complex systems that prevent divergence between the price of the asset and the stablecoin.
It isn’t easy to create a stablecoin that is backed by the asset to which its value is pegged. This is because of several reasons. The issuing company has to own the underlying assets and people have to trust that the company really owns these assets. Additionally, there are major security threats to be solved, logistic issues, profit-making problems and dealing with overhead costs. How is such a company going to make profit if it costs 15% of an asset’s value to transport it, lock it up safely and pay for overhead, but the stablecoin can only be sold for its market value?
On the other hand, stablecoins that represent the value of an asset without being backed by that asset require incredibly complex mechanisms to ensure that the stablecoin actually remains stable in value relative to that asset.
The Benefits of Stablecoins
Stablecoins have the potential to boost the use of cryptocurrencies and push them into mainstream usage. This is due to the absence of the enormous price volatility which most cryptos are susceptible to while leveraging the benefits of blockchain technology.
This major benefit is particularly well-demonstrated in the remittance market. Remittances are financial transactions made by people who work overseas who send their wages home to their families. This large financial sector is highly inefficient due to the high cost of these remittances; and it’s the users who suffer as their wages are eaten up by high transaction costs.
Blockchain technology offers a way to make this industry far more efficient. However, due to the price volatility of cryptocurrencies, they are still far from the ideal solution for migrant workers. If a migrant worker sends Bitcoin to his or her family back home, a sudden 15% drop in value still means that 15% of the value has vaporized.
Stablecoins solve this issue by allowing anyone to open up a wallet and enabling near instant transactions of these coins, but with the absence of price volatility.
The above described benefit applies to many more industries that want to leverage the benefits of cryptocurrencies but don’t want to be exposed to the price risks. For instance, retailers can start accepting stablecoins for purchases, individuals can use stablecoins as a store of value and don’t need to go through third parties to transfer and store these digital assets, and anyone with access to the internet can open up a stablecoin wallet.
These are advantages that will make stablecoins highly useful in the future once crypto finds its way into mainstream, but they also present major advantages to parties that are already in the crypto space like investors, traders and providers of crypto-related services.
For investors and traders, stablecoins provide a safe haven during a market crash without having to transfer their capital back to fiat currencies. Through stablecoins, this protection can be executed within minutes without having to deal with issues related to fiat currencies such as:
- Lack of fiat currency support in exchanges: Only a few exchanges support fiat currencies due to strict regulations. However, transacting with stablecoins is much easier to allow for.
- Slow transaction times: Sending fiat back and forth between your bank accounts takes days.
- Regulations limiting crypto transactions: Banks are cracking down on crypto-related transactions, meaning that overnight you could be prevented from sending money to a crypto-related company.
Additionally, stablecoins allow decentralized exchanges to create crypto-fiat trading pairs. Onramps for fiat to decentralized exchanges have been proven to be extremely difficult as most financial companies don’t want to get connected with these exchanges.
Stablecoins solve this problem. This is great news as decentralized exchanges (DEXs) are unhackable on a broader scale; only individuals can get hacked but not the exchange as a whole. DEXs have been having a hard time attracting traders and stablecoins could give rise to a great influx of new users.
Moreover, stablecoins solve the problem of having to think in terms of Bitcoin or Ethereum when trading cryptocurrencies. Since most exchanges don’t deal in fiat, investors and traders have to think in crypto values.
This is quite inconvenient, especially for new entrants, and this has had a quite negative impact on the market as a whole, as displayed by Bitcoin’s massive influence over the market as a whole. Does it make sense that NEO drops when Bitcoin does? Not really, but it happens over and over again. Stablecoins can solve this problem by introducing stablecoin-altcoin pairings.
Changing (Crypto) Economics
Stablecoins could become the holy grail of cryptocurrencies as they could boost mainstream adoption. This is because they allow for an entry into the crypto space without exposure to the market’s high volatility. In this way, individuals are introduced to the benefits of cryptocurrencies and blockchain technology but are protected from the risks associated with price volatility.
This means that people in Venezuela or Zimbabwe who are currently being financially destroyed by their incompetent governments could store the monetary value they possess in stablecoins, without having to see that value crash once more through a crypto market crash.
Beyond this, stablecoins present another novel and disruptive idea.
The US, followed by most of the rest of the world, abandoned the gold standard in 1971, turning the US dollar in a non-backed, unlimitedly printable and thus corruptible asset. The US dollar became a stablecoin without actually being held stable to anything.
Through stablecoins, we could reverse this action by tokenizing gold. Gold never really was the best way to pay for your bread and butter, but with a gold-backed stablecoin, we could actually start paying for groceries with gold.
With a transparent model in which it’s clearly asserted that the gold-pegged stablecoin is actually backed by an equal amount of gold, we can reset one of the biggest mistakes in economic history and start paying with (digital) gold.
This idea can be applied to other commodities and assets, and this could create entirely new economic models. Commodities such as gold and silver and many other assets typically aren’t very accessible to invest in for the average citizen, but this is something that can be made possible through stablecoins.
An Overview of Stablecoins in Today’s Crypto Market
USD Tether (USDT) currently is the best example of a stablecoin in the crypto market. The USDT is directly coupled to the USD price. With a market cap of above $2 billion at the time of writing, it’s by far the most used stablecoin.
To keep USDT aligned with the USD, the stablecoin is supposed to back every USDT with US$1, meaning that they should have over US$2 billion sitting somewhere in a bank account(s). Whether this is actually true remains the question; this, together with a whole lot of other questionable activities surrounding USDT, is often referred to as the Tether controversy.
Similar to USDT, the Truecoin project has been working on a cryptocurrency pegged to the USD. Having learned from Tether’s issues, Truecoin’s TrueUSD is 100% collateralized in USD escrow accounts. These escrows are managed through multiple bank partners which legally protects token holders by giving them enforceable legal rights.
Moreover, the auditing of TrueUSD is transparently done on a monthly basis. The company provides certificates of ownership through trusts, proving that the underlying USD is really in their bank accounts. TrueUSD is a welcome newcomer which gives cryptocurrency traders peace of mind due to their transparent and legally-compliant approach. This is a particular relief given the rising tensions and suspicions surrounding USDT.
Truecoin’s model for the USD-pegged coin is just one out of many stablecoins the company wants to provide. Other fiat currency and municipal bonds are already in the making.
Kowala is another company that created a stablecoin, kUSD, which is pegged to the USD. They keep their coin stable through smart contracts and use a decentralized approach.
There is also Basecoin. They use base bonds protocol, meaning they issue bonds when the basecoin is trading below US$1.
Stablecoins With Alternative Underlying Assets
Maker is the company that introduced DAI, another cryptocurrency that is pegged to the value of the USD on a 1:1 ratio. DAI’s value is kept stable in relation to the US dollar using a system of collateral and price feeds, but is not backed by actual USD holdings.
Instead, the DAI is created on demand and backed by collateralized ether. This collateral is managed by the Maker community, the MKR token holders. Maker’s DAI is a stablecoin that completely lives on the blockchain. It is automated through the use of smart contracts built on the Ethereum blockchain, and utilizes a complex design to keep its currency stable.
For a full explanation on Maker and DAI’s mechanisms, read our guide to MakerDAO.
The Globcoin is a stablecoin that represents a basket of the 15 largest currencies in the world and gold. Through this diverse basket, the company behind the coin tries to provide the most stable coin possible for their investors and traders.
Moreover, this diversified basket of currencies provides a solid hedge against global purchasing power parity discrepancies. This means that this cryptocurrency, if successful, could become a perfect hedge against global currency exchange risks.
The SwissRealCoin is a stablecoin backed by a portfolio of Swiss real estate, an asset class that is proven to be highly stable. It is the world’s first stablecoin that promises to increase in value based on the growth in value of the underlying real estate.
To prevent volatility, an increase in demand for the cryptocurrency is used to issue new coins. The revenue from token sales is then used to increase the size of the real estate portfolio. Another cool feature is that all token holders can vote democratically on the investment choices.
Digix Gold Tokens
Digix Gold Tokens, as its name suggests, is a cryptocurrency backed by actual bars of gold. To ensure that the currency is actually backed by gold, Digix Global, the company backing the coin, uses a Proof-of-Asset mechanism and asset cards. These PoA asset cards are certificates proving that the gold is actually in possession and include signatures of three unrelated parties involved in this evidential process: the vendor, the custodian and the auditor.
Digix is decentralized and autonomous (DAO). DGD token holders, a token based on the Ethereum blockchain, make decisions regarding DigixDAO’s developments. To read more about DigixDAO, click here.
At first glimpse, stablecoins provide an easy and fast way for traders and investors to protect themselves from cryptocurrency price volatility. They can also be used by exchanges and decentralized exchanges to boost volume and number of users through stablecoin-altcoin pairings, decrease the market’s dependence on Bitcoin’s value, and decrease the dependence on fiat currency onramps.
That being said, stablecoins aren’t much of a safe haven when the issuing company is surrounded by controversy (case in point: Tether). Thankfully, other companies that are providing more trust and transparency are moving into the stablecoin space to capture some of Tether’s market capitalization.
When digging deeper into their workings, stablecoins can become much more than a safeguard and trading tool for investors and traders. When implemented and executed properly, these coins could boost mass adoption of cryptocurrencies by protecting new entrants from the risks of cryptocurrencies while introducing them to the inherent benefits of this new digital asset class. The remittance industry is an example of how stablecoins can do this.
Price stability is a key requirement for cryptocurrencies to go mainstream and stablecoins could provide just that. They can become an excellent medium used by retailers and consumers for daily transactions.
If stablecoins can be implemented properly, in addition to being trustworthy, scalable and secure, they could become one of the foundations of the emerging digital cryptocurrency-based economy.