What are Stablecoins – Removing the Veil of Mystery
Intro: Ever since cryptocurrencies first appeared on the market, one of the main hurdles for their mass adoption was the fact that they are wildly volatile. Enter stablecoins – cryptocurrencies that everyone can understand, use, that no one should be afraid to hold, and, most importantly, that can make all of our lives a bit easier.
When Bitcoin (BTC) became the constant topic for news portals worldwide, people’s interest in it began to grow. However, what most people realized rather quickly was this simple truth – that it’s highly volatile asset with enormous upswing and downswing risks.
Yes, it is well known that cryptocurrencies are decentralized, that they don’t depend on the will of one central authority or a consortium with intertwined interests. And yes, every citizen of every country in the world might benefit from using cryptocurrencies over fiat. But, most people aren’t willing to risk a large portion of their savings, even if a digital currency makes them independent from fiat volatility in their own countries. That’s where the crypto train got stuck. Crypto “maximalists” believe that BTC and other coins will ultimately replace all the money in the world over time (just ask crypto influencers such as @themooncarl).
Bitcoin is the best form of money that has ever been available to humans, and soon the rest of the world will realise it.
— The Moon (@themooncarl) May 16, 2019
Although their belief is strong, the problem lies in the fact that you can’t use something as volatile as BTC or ETH (Ethereum) for your everyday purchases of goods and services. Just remember the man who paid 10,000 BTC for two pizzas. Those pizzas were worth $30. Imagine how he feels now, when 1 BTC is around $8.5k, knowing that he could have been a millionaire .
This is the most practical example of why we need a cryptocurrency with a relatively stable value that doesn’t vary wildly based on statements from government officials, or fluctuate based on the price of computer parts, natural disasters, terrorist activities, political upheavals, or rumors.
So, its clear we need a lot more stability in the world of crypto. But, it seems there’s a lot of fuss around each new stablecoin, especially since Facebook announced Libra, and Binance announced the Venus project. Why is this so?
The Core of the Matter
At their core, stablecoins are a response to the wide-spread need for a digital currency that is independent from banks and governments, maintains its value over time, and can be used for cross border payments.
Stablecoins are cryptocurrencies designed with the goal of significantly decreasing price volatility risk. They are usually stable relative to a value of a globally accepted asset or a basket of assets.
Origin and Rise to Popularity
Once crypto project developers realized the demand for a stable currency exists in this new market, they started frantically working on a solution.
The very first stable coin project, bitUSD, was launched on July 21st, 2014. Built on the BitShares blockchain, bitUSD is a coin pegged to US dollar but backed with BitShares’ token BTS. Although bitUSD is far from stable, with a price fluctuations from “stable” $1 to $34 at one point, this project has prompted innovations with the rest of blockchain development community.
After dozens of stable coin projects and through trial and error, four main types of stablecoins have emerged:
- Fiat-collateralized stablecoins – every coin minted is backed by one unit of fiat currency. This was the main idea behind Tether, the most popular stablecoin at the moment.
- Crypto-collateralized stablecoins – each coin is backed by other cryptocurrencies. One of the most popular examples of this type is MakerDAO’s DAI token that is collateralized with ETH at a ration of $1.5 worth of ETH for each $1 worth of DAI.
- Non-collateralized stablecoins – algorithmic stablecoins that have an elastic supply that depends solely on the supply and demand. One of the best examples of this model was Basis, a stablecoin that had to shut down in December of 2018 because of regulatory issues.
- Commodity-collateralized stablecoins – stablecoins backed by supplies of real-world assets, such as gold, real-estate, iron or oil. DigixGlobal stablecoin is backed by gold stored in Singapore vaults, and its market price correlated to the market price of one gram of gold.
Why Have Stablecoins Gained Popularity?
When you look at the cryptocurrency market, you will notice that, although exciting, it lacks something stable to hold on to. So, as soon as something that fits that description appeared, the crypto community accepted it. Numerous crypto traders and early adopters depended on quickly switching from one cryptocurrency to another, or even into fiat, in times of market instability, but even with the speed of blockchain, it made some loses inevitable. So, once a stable cryptocurrency appeared, the crypto community finally had a safe(r) hedge for their crypto holdings, without having to go through the arduous transfer into fiat.
On the other hand, the newcomer enabled faster sending funds across borders without paying for huge bank transfer fees. So now anyone could enter crypto, and use it, without the fear of volatility that comes with, for instance BTC.
And, let’s not forget about the allure of simplicity. While most cryptocurrency projects have confusing explanations, are unclear whether they are minable or not, have low to no liquidity, stablecoins are rather simple and transparent. Although Bitcoin makes up for about 70% of all the digital-asset world market value according to Bloomberg, the token with the highest daily and monthly trading volume is a stablecoin – Tether.
At the moment, the most popular stablecoins are Tether, USDC, Paxos, TrueUSD, and DAI, with a total daily trading volume of about $21.9B.
For the reference, at the moment of this writing, there are 2963 cryptocurrencies with a total market cap of $230B, and 24h volume of $61B. That means that in a very short time, stablecoins have managed to make up one-third of the entire cryptocurrency trading market. And even though BTC still holds the most value, these stablecoins are the ones having the largest impact on the market, as they are being used as a currency on a daily basis.
Let’s see what each has to offer, together with its pros and cons.
List of stablecoins
Daily trading volume – $21,018,336,006
The most popular stablecoin is pegged to USD, and has managed to achieve a very wide adoption and high liquidity.
Despite high adoption rate, it’s also the main reason for the lack of trust towards stablecoins. Tether is supposedly collateralized with USD 1:1. But, it was recently discovered that the largest player in the stablecoin market is only 74% backed by USD. In addition, there’s a new problem – a class action lawsuit against Tether and BitFinex for market manipulation.
Daily trading volume – $530,639,500
Paxos is one of the few regulated stablecoins. In fact, it’s approved by the New York State Department of Financial Services. Pegged and collateralized with USD, Paxos has succeeded in maintaining its value peg. It’s main flaw lies in the fact that it is centralized – contrary to what the ideal cryptocurrency should be in order to remain stable in spite of market volatility.
Daily trading volume – $217,893,208
Fiat-pegged and collateralized, this system is fully transparent, pegged to the USD, and it works with reputable auditors and partners. This stablecoin is centralized, and the main reason why certain parts of the crypto community dislike it, is the fact that management retains the right to blacklist addresses and freeze funds.
Daily trading volume – $171,432,526
This asset-based token is also redeemable at a 1:1 ratio for USD. It was developed as a response to Tether’s lack of proper backing. TrueUSD solved this problem by entering partnerships with banks and fiduciaries that are able to handle their funds.
Daily trading volume – $21,256,692
The only stablecoin on this list that isn’t fiat-collateralized, Maker DAO’s DAI is a rather complex project, which is, presumably, why it’s popularity grows so slowly. It is pegged to USD and backed by Ethereum. Although DAI has a very loyal community, it hasn’t performed as well as expected in the real-world conditions, in fact, it has been under $1 for the most of 2019.
The Loudest Newcomers
Now that the crypto market has shown that it likes stablecoins, the big players have decided to waltz in. Now, they may not be completely decentralized, and they may not even be real cryptocurrencies, but they are loud, and they have turned the eyes of the entire world towards the crypto space.
From the moment when it became obvious that cryptocurrencies are here to stay, there have been rumors that Facebook is developing one of its own. However, these were mostly quickly dismissed due to the failed attempt from 2009, called Facebook Credits (10 of these were an equivalent to $1).
Well, we were wrong to dismiss these rumors, because if Mark Zuckerberg is anything, he’s persistent. So, this spring, we’ve seen the blossoming of his newest project – Libra.
Functioning as a stablecoin pegged to a basket of currencies and governed by the Libra Association’s Council that is comprised of members such as PayPal, Spotify, Lyft, Uber, Ebay, Mastercard, Visa, Thrive Capital, and Andreessen Horowitz, Libra is supposed to also offer instant liquidity.
The main flaws the crypto community sees in this project are as following – giving personal financial data to big corporations that might abuse it and not adhering to the basic principles of blockchain technology.
Thanks to Facebook’s reputation, this project has received a lot of attention from the media, but also from the governments. The US Congress has expressed serious concerns regarding Libra and its intentions, so Congress hearings are being conducted to determine their functioning and understand their intended use cases.
So, from one perspective, Facebook can help boost wide adoption of cryptocurrencies. From the other, if Facebook’s privacy issues repeat, it can make people sceptical towards all stablecoins, and crypto in general.
In response to Facebook’s Libra, numerous other companies have announced their own stablecoins, so it doesn’t surprise that Binance announced its Venus project in August.
Meant to develop localized stablecoins on an open blockchain project, Venus intends to provide an independent, regional version of Facebook’s Libra.
Pushing adoption, yes. Domination, no. Always happy to co-exist.
In fact, this should help Libra, if you think about it. Will leave it at that. https://t.co/HLSywLb2mi
— CZ Binance (@cz_binance) August 19, 2019
According to Binance, they want to give more financial autonomy to developing countries while at the same time protecting the financial security of these parts of the world.
And while Libra is partnering with 27 companies, Venus still hasn’t announced any partners, but their announcement that they are looking for partnerships and alliances with governments and corporations tells us that this announcement isn’t far away.
This project has the potential to simplify and inspire the use of cryptocurrencies in developing countries, but can also fall into the trap of becoming a simple digitalization of fiat, dependent on fluctuations of the fiat markets.
Like every other innovation, blockchain, cryptocurrencies, and especially stablecoins need to be properly legally regulated. The problems emerge when people who are creating regulations don’t understand the innovation in question.
Stablecoins are, unfortunately, a victim of this lack of understanding, and it is one of the reasons why their further development and adoption has been slower in recent months.
Number one issue is whether a stablecoin is a security or not. Let’s see why.
Securities are financial instruments that have some monetary value, and they are usually split into two distinct categories – equities and debts. Equities represent ownership a shareholder has in an entity, while debts represent money that was borrowed and has to be repaid in a specific amount, with a specific interest, and with a particular renewal date.
Basically, if something is a security it either guarantees a stake in the company, or it offers a potential profit to its buyers. As long as a stablecoin or a cryptocurrency can be perceived as a speculative contract, it can be deemed to be a security.
Now, we’re not saying we agree with this interpretation, as stablecoins mostly don’t fit it, but are often forced to be security regulation compliant. Would you call the USD a security? Or Euro? GBP? No? Neither would we, however, most government institutions refuse to recognize cryptocurrencies as currencies, which is where these projects tend to stumble.
For instance, a very promising stablecoin that appeared on the market in August 2017, Basis, had to close its doors in December 2018, because it wasn’t SEC-compliant in it’s country – the US. Basis was a stablecoin that was based on an elastic coin supply, but pegged its price to $1. It’s founder, Nader Al-Naji used to describe it as a project that uses code to maintain price stability, the same way the US Federal Reserve does for the USD.
This was the best funded stablecoin project at the time, and both the community and its partners truly believed in its potential. It managed to secure $133 million in funding. And it had to shut its doors due to the fact that the regulatory landscape was too rigid, and there was no way for them to avoid the status of a security.
Libra to clear the path for others
Facebook’s Libra is facing its own set of potential legal issues, as we have mentioned previously, on one side of the ocean, the US Congress is conducting hearings regarding this new crypto project, while on the other side, in the UK, the Bank of England has set out its own rules for Libra’s launch in this country. However, the social media giant has experience in handling government concerns regarding its products, so we believe it will manage to do so in this case as well.
Hope for future projects
While Basis has failed due to regulatory issues, and Libra is stalled due to them, there is still hope that stablecoin projects that are coming will face less problems. Governments of countries have recognized that the blockchain technology is here to stay, that the cryptocurrency market is becoming larger and larger, so they have started reaching out to influential figures from the crypto space, and including them in advisory bodies that have the task to facilitate creating laws and regulations that will control the space without suffocating it.
Potential for the Future
The idea behind the creation of stablecoins is simple – you want something solid to hang on to, regardless of the market volatility. And while the first stablecoins were only focused on the crypto markets, it is now easy to recognize the benefits that they can bring to the traditional markets as well.
While BTC and USD fluctuate based on what’s going on in the States, stablecoins don’t have to. Bear in mind that domestic fiat currencies in countries that are going through political turmoil such as Iran and Venezuela experience almost incredible inflation rates, and these projects could offer a solution that the families in those countries really need. Finally, one attack on Saudi oil fields can shake up the entire Forex market, whereas it does absolutely nothing to stablecoins.
Now, not every coin is immune to inflation, after all, a lot of them are pegged to single currencies. Those coins simply follow the value of the fiat money they are connected to.
But, stablecoins that peg themselves to baskets of currencies and look for ways to become independent from individual markets remain immune to such changes. That means that you can save for your children’s college fund in stablecoins instead of fiat, and remain confident that your country’s inflation won’t eat through those savings. It means that you can send money over to your family abroad, without worrying that tomorrow’s state on the international markets will decrease the value of what you sent. It means that you can start buying and selling goods and services in exchange for stablecoins without concerning yourself with exchange rates, bank fees, or transfers.
This all sounds very promising, but, that doesn’t mean that you should go and sell all of your BTC, or exchange all of your fiat and enter stablecoins. Unfortunately, like most of the crypto industry, they are still largely not regulated, and if they are it’s partial at best.
Sure, this niche of the crypto space will grow in the coming years, but its long-term potential depends on the proper implementation of legislative measures, good intentions of stablecoin project founders, and, in the end, the faith that late adopters are willing to put into this new form of money.