Stablecoins

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Beginner

By Matt Hussey

Learn

Jan 16, 2019

A stablecoin is a cryptocurrency designed to have low price volatility. Stablecoins are used as stores of value or units of account, as well as in other use cases where volatile cryptocurrencies may be less desirable. Different stablecoins use different strategies to achieve price stability, some are centralised, others are decentralised.

What you will learn

What you will learn

What stablecoins are, examples of stablecoins, why are they so popular and what are some of their disadvantages

Cryptocurrencies have been, since their inception, very volatile when it comes to price. That's lead to price jumps and crashes, preventing cryptocurrencies from being used for everyday goods and services. That's where stablecoins come in. The theory goes, if you create a currency that is 'pegged' or attached to a regular fiat currency like the US dollar, it will prevent price swings.

We explore these more below.

What is a stablecoin?

Stablecoins are cryptocurrencies that claim to be backed by fiat currencies—dollars, pounds, shekels, rubles, etc. The idea is that, unlike cryptocurrencies like bitcoin, stablecoins’ prices remain steady, in accordance with whichever fiat currency backs them.

What are some examples of stablecoins?

Centralized stablecoins:

Tether (USDT): Tether is the one of the first stablecoins and the most famous. It claims it is backed by a reserve of real dollars—”collateral”—that is “off-chain,” i.e. in a real-world location that is controlled by a centralized third party.

With this stash safely in the vault of a bank, investors can be confident that their tethers really are worth one dollar each, keeping the price steady. There’s only one problem: Tether Ltd, which mints tether tokens, has never conclusively proven that the currency really is fully backed, fuelling doubts among investors. (More on this below)

Gemini Dollar (GUSD)/Paxos Dollar (PAX)/USDC: Developed by venture capitalists the Winklevoss twins, blockchain startup Paxos, and crypto exchange Coinbase (in concert with payment platform Circle) respectively, these stablecoins are currying favor with the institutional investors—all have been closely audited by Wall Street firms and are compliant with local regulatory regimes. As Tether becomes less trusted, these tokens only become more popular.

Petro: The petro is a cryptocurrency developed by Venezuela. The government claims it is backed by the country’s oil reserves, among other valuable commodities, like gold. At its heart, it’s an attempt to create an alternative to the hyperinflationary Venezuelan bolivar. However, Reuters found earlier this year that the coin might not exist—it simply found no sign of it.

Decentralized stablecoins:

Terra: Terra is a decentralized stablecoin, which means rather than relying on a trusted third party it uses a complex algorithm to keep stable. To do this, it balances “on-chain” reserves—i.e. the funds are held in smart contracts—with supply and demand automatically, mitigating the chances of traders accidentally—or intentionally—fiddling the price.

Why have they become so popular?

Stablecoins are enormously popular: Tether, for instance, is the second most traded cryptocurrency after bitcoin, with a 24 hour trading volume of $4.7 billion (at time of writing).

There are two main reasons people choose stablecoins over cryptocurrencies like bitcoin.

  • They’re (relatively) stable. Because they are supposedly backed by fiat currency, investors can be confident that their tokens will always sell for one dollar each. This supposedly means that the prices won’t fall: coin prices are driven by belief, so if investors believe their stablecoins are worth and backed by one dollar each, the price should reflect that.

  • They’re a safe haven for worried investors. Many exchanges—including Binance, the world’s largest—don’t let traders buy fiat currency, and only let them buy and sell cryptocurrencies. This means it’s often tricky for investors to swiftly cash out their cryptocurrencies when the going gets tough. To do so they might have to transfer across several exchanges, or even wait several days.

This is where stablecoins come in. Because they are cryptocurrencies, they live on most exchanges. Yet because they hew to the value of a single fiat currency, they act as a sort of temporary refuge for investors looking to secure their funds during a bear market. In this way, stablecoins are like blockchain-enabled versions of the dollar. That’s if they retain their value.

Disadvantages

Investors need proof the coins are backed by reserves. In Tether’s case, this wasn’t provided, sparking rumors that the currency was unbacked and was in fact minted out of thin air.

Stablecoins aren’t necessarily stable. The Gemini Dollar increased by a few cents last month as traders poured money into it. Ironically, many of those investors’ funds had come from Tether—which had sank on some exchanges to a record low of $0.51. This dispelled the stablecoin myth, somewhat.

The idea of a fully-backed, audited cryptocurrency is anathema to many crypto diehards. They say it’s pointless, and that it betrays a lack of trust in regular cryptocurrencies: you may as well do away with the whole crypto project if you’re just going to use it to recreate a lesser version of the.dollar.

Did you know?

Tether has consistently failed to provide proof of its dollar reserves. It managed to release one audit but the law firm that carried it out, Freeh, Sporkin & Sullivan LLP, swiftly downplayed its auditing credentials when scrutinized.

The future

With the crypto boom of 2017 behind us, investors are increasingly looking to stablecoins as a safer way to experiment with the technology. As more respected players throw in their weight—the Winklevoss twins, Circle, and Coinbase, for instance—the idea of a “digital dollar,” a shadow currency that takes fiat onto the blockchain without risking its value, is ever more tantalizing.

By Matt Hussey

Learn

Jan 16, 2019

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2019 © Decrypt Media, Inc. All Rights Reserved.

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