Cryptocurrency markets are notoriously volatile. Capable of going from breathtaking leaps in value to stomach-churning nose dives, all in a matter of hours. It usually takes the traditional stock market a whole year to log the movements crypto does at a daredevil pace. With crypto to fiat trades experiencing regulatory crackdowns in several jurisdictions globally, it’s been getting harder for investors to find the price stability required to mitigate the loss of value during a downturn. That’s where stable coins come in. Offering users the relative price stability of traditional fiat currencies, combined with the openness of blockchain.
How are stable coins different from traditional cryptocurrencies? Well, unlike a regular cryptocurrency, whose value ebbs and flows according to market interest and just about any regulatory murmur, stable coins are usually pegged – on a one-to-one basis – to either a fiat currency or commodity (Gold, Silver, Oil, or what have you.). Stable coins offer significant inherent value as they represent ownership of an actual physical asset.
David Yernack, professor of finance at New York University stated, in a paper published back in 1013 that “for any currency to be useful to society, it should be able to function as a medium of exchange, a store of value and a unit of account.” Though Prof Yernack was using these criteria to fire shots at Bitcoin’s feasibility as an everyday currency, he had a point. Some cryptocurrencies can, to some degree be used as a medium of exchange, they tend to do poorly as stores of value or units of account as a result of their steep fluctuations. This creates a need for stablecoins.
“Unlike cryptocurrencies such as Bitcoin, which are highly volatile, stable coins provide people with the pragmatic, helpful benefits of a cryptocurrency, without having to worry about distressing price changes since they are grounded in the real world.”- Brigitte Luginbühl, CEO of SwissRealCoin
Stable Coin Types
As previously stated, stablcoins and their almost fixed value offer a relatively safe cushion for the value of your crypto tokens should market suddenly veer off in the wrong direction. Price stability goes a long way towards promoting the mass adoption of cryptocurrency and is a fundamental requirement for the introduction of reliable blockchain based financial products like savings and loan services.
There are 3 types of stable coins available today the most popular being Fiat Collateralized stable coins. Ths type of coin pegs it’s value on a 1:1 ratio with an existing fiat currency. It’s basically an IOU system where for every token issued, an equal amount of fiat is stored by a central custodian. This means token holders can at any given point, trade their tokens for a corresponding amount of fiat. There can, therefore, only be a certain number of coins in circulation as there is really only so much fiat running around out there.
Popular fiat collateralized coins
Popular among crypto traders as a market-dip buffer, Tether (USDT) is pegged 1:1 against the US dollar is held by a central custodian. Despit maintaining stable value, Whether has repeatedly come under scrutiny, believed to not be as sufficiently collateralized as they claim. As they, as yet, have not submitted to an official audit.
Developed on the TrustToken platform, USDT is a US Dollar collateralized token who’s reserves are held in escrowed accounts, subject to daily audits. Despite efforts to be transparent and legally shield users, TrueUSD was received with a lot of doubt by the crypto community.
More Asset/Commodity Collateralized than Fiat Collateralized, DGX pegs each token to a gram of a 99.99% LBMA approved piece of that shiny, empire building and destroying dirt we all love…GOLD! The kicker though, is that because Digix is pegged to gold, the price is still given to fluctuations. This means, with respect to the USD or any other fiat currency, there’s virtually no stability to be had here. Also. The gold collateralized cash system is so pre-1971.
Then there’s Venezuela’s El Petro token. President Maduro’s controversial brain child is pegged, coin to barrel, to the South American nation’s oil reserves. We’re talking $6 billion worth of first world fuelling, blacker than molasses, crude oil. Or so it is claimed.
There are those who believe El Petrol is a scam. Members of Maduros government have even gone as far as declaring petro illegal. One Jorge Millan even called Petro a “forward sale of Venezuelan oil”, an outright an attempt at fraud.
What we have here are crypto tokens back by crypto tokens. The idea behind crypto pegged tokens is to avoid the centralization of fiat backed tokens and somehow “achieve stability in a completely decentralized ecosystem”. It goes without saying that pegging a crypto coin to an equally potentially volatile coin is like milking a snake.
To mitigate the risk, crypto collateralized coins are usually over-collateralized. The excess funds act as a buffer from market fluctuations. This means that, for a single stable coin you purchase, you drop two of the coin it’s pegged to. Giving it a comfortable 200% collateralization to protect it from a drop in value. Crypto collateralized tokens are more decentralized and usually enjoy high liquidity but are unlikely to see day to day activities.
Popular crypto collateralized coins:
Bitshares uses it’s native currency Bitshares to collateralize market pegged assets, BitUSD, BitCNY, and Bitgold. One can then trade these tokens like derivatives contracts and increase the collateral.
MakerDAO developed, Dai, is US dollar pegged and collateralized with ETH. Users can generate Dai tokens by depositing ETH in the smart contract.
Havven achieves coin stability by using their Haven token to collateralize their network, then issue their nUSD token against the value of the collateral. The system is stabilized by having users stake Havven tokens as collateral for nUSD tokens in exchange for network transaction fees.
Non-Collateralized coins endeavor to mimic fiat currencies in that they don’t have any asset-backed collateral. Instead, they achieve stability through a system called seigniorage shares. Conceived by founder and CEO of Clearmatics Technologies LTD, Robert Sams, the seigniorage process uses smart contracts programmed to act as an autonomous reserve bank. Increasing and decreasing the supply of funds according to keep token value as close as possible to the value of the asset it’s pegged to.
Non-Collateralized tokens are probably the most likely type to be used for daily use. The downside is that current versions require continuous network growth for stability mechanisms to work. This makes them highly susceptible to market crashes and loss of user interest.
Popular non-collateralized coins:
Remember BaseCoin? It’s called Basis now. Basis uses seigniorage pegged to the US dollar, with plans to peg to a Consumer Price Index as it is designed to be used for the purchase of goods and services.
Saga aims to be backed by variable fractional reserves pegged to the IMF’s special drawing rights.
Stable coins are set to climb the ladder as some of the most in-demand crypto assets as the industry matures and more institutional participants enter the marketplace.”- Fran Strajnar, head of analysis firm, Brave New Coin.
Mr. Strajnar may be right as the US’s fifth bank, Goldman Sachs recently announced a stable coin of their own. USDCoin or USDC, as you may have guessed, is a US Dollar backed stable coin that aims to address the various shortcomings of current stable coins. Transparency is one of them. USDC, an ERC20 token developed by Sachs’ fintech startup Circle in collaboration with CENTRE, Bitmain, and others, will also operate within the regulatory framework set by US money transmission laws and “reinforced by established banking partners and auditors”.
Whether stable coins become the backbone of the coming digital economy remains to be seen. Right now, it’s anyone’s game. If they can get past current technical flaws and regulatory hurdles, stable coins could very well lead the charge in ushering in the decentralized economy.