There are now over 2,000 different cryptocurrencies, sometimes referred to as coins or tokens. One of the biggest concerns to some, though, is that cryptocurrencies are often not backed by anything. Enter the stablecoin, cryptocurrencies backed by real assets or fiat currencies. Cryptocurrencies like Bitcoin, with no underlying asset are at the whim of market forces, making them far more volatile than any other investment market. This volatility makes cryptocurrencies difficult to use for more mundane means, like wages payments, and paying for goods and services. Stablecoins aim to solve this challenge.
The number of stablecoins has risen from none to nearly 30 now live and trading. There are reports of 120 stablecoin projects and launches in various stages of development.
Stablecoins are designed to combat price volatility compared to other cryptocurrencies and to behave more like conventional money, such as dollars or euros. The overarching characteristic of most stablecoins is that they are pegged to another asset. The first stablecoins were pegged to the U.S dollar but later stablecoins are appearing pegged to other assets, like gold, and other global fiat currencies.
Some reserve-backed stablecoins are backed by other cryptocurrencies, giving them a new name of crypto-backed stablecoins. They are technically both reserve-back and crypto-backed stablecoins. They keep the decentralized and unconventional nature of digital currencies and have a store of another cryptocurrency behind them. Instead of using a fiat currency or precious metal like gold, crypto-backed stablecoins use the underlying value of a cryptocurrency to combat the volatility of the stablecoin.
[maxbutton id="1" ]
The underlying supply and coin are then manipulated - manually increased or decreased - to prevent price fluctuation and continue the peg to a given cryptocurrency. Its worth noting that not all stablecoins will be 1:1 pegged to a cryptocurrency, but could be tied to fractions or multiples (for instance, one stablecoin could be pegged to two ETH).
A new type of stablecoin is emerging called the algorithmic stablecoin. This type is price-controlled via a computer algorithm made to mirror the performance of being pegged to a conventional asset like the dollar. The algorithm can potentially make a stablecoin less volatile than reserve-backed coins since it wont be subject to market whims and can be more flexible to market conditions than some assets like a fiat currency or gold. The algorithm addresses the volatility concern by increasing or decreasing the number of coins in circulation on the basis that fewer coins in circulation will increase price and more will decrease the price. Garrick Hileman, head of research at Blockchain (the company, not the technology) explained to Business Insider:As demand for an algorithmic stablecoin increases, supply also has to increase to make sure there's not an appreciation in the value of the stablecoin. At the same time, as the value decreases, there needs to be a mechanism by which supply can be reduced again to try and bring the price of the stablecoin back to the peg.Despite algorithmic stablecoins having a lot of benefits, they are still at the whims of the market - potentially leading to higher volatility - and there is risk that the algorithm could be manipulated by hackers if they gain access to it.
Tether was the first stablecoin to appear on the cryptocurrency market and launched in November 2014. It was designed to provide a utility token that represented the US dollar at a 1:1 ratio while still providing the speedy transfer capabilities of a cryptocurrency. Tether tokenizes dollars by exchanging them for the Tether coin and keeping the dollar backing each coin in a bank account. This purportedly removes the risk associated with other cryptocurrencies as Tether has a physical asset or money backing, so it theoretically follows the price of the dollar equally. In principle, if a Tether owner wishes to convert back to fiat, they can be assured of the of the value of their holdings. Tether has also seen much criticism in recent years and was required to prove in 2018 that it held equivalent dollar balances to the amount of Tether in circulation. It has also been subject to claims of cryptocurrency market manipulation, the latest have made it subject to a probe by the U.S Justice Department. These federal prosecutors are investigating if Tether leveraged their relationship to cryptocurrency exchange Bitfinex in order to illegally influence Bitcoin price during its price-peak in 2017.
Stablecoins are often used today to provide liquidity for cryptocurrency exchanges. Some exchanges struggle to obtain conventional bank accounts which prevents them from offering fiat-to-cryptocurrency transactions or allowing fiat balances to be kept on exchanges.Users of cryptocurrency exchanges, particularly traders, prefer to have the option to transfer their funds away from high volatility coins like Bitcoin in times of uncertainty or unpredictable price fluctuations. If cryptocurrency traders cant exchange their balance of Bitcoin to dollars on an exchange to prevent losses, for example, they may choose to transfer their balance to a stablecoin which they know will behave in the same, less volatile, way as fiat currencies. This use of stablecoins to combat loss and volatility has led to the creation of exchange-tied stablecoins, launched by exchanges themselves. The Gemini Dollar is one example and was recently approved by the New York Department of Financial Services (NYDFS). It has become one of the first digital coins representing the US dollar to be regulated and approved in the U.S.
Stablecoins are pitched to solve the problem of volatility that prevents cryptocurrency use for some financial transactions, like wages, insurances, dividend payments, and loans.For this reason, and as a solution to liquidity, new stablecoins are emerging with many new projects initiated in 2018. Around $350 million USD (Approximately $467 million CAD) worth of venture capital funding has been raised by stablecoin projects so far. The combined value of all live stablecoins by market capitalization is around $3 billion (over $4 billion CAD). Issues like the ones Tether faced create an opportunity for other stablecoins, but new projects will still face an issue of scale. The scale issue for stablecoins is the need to have millions, billions, or even trillions in circulation and equally sufficient reserves to compete with fiat currencies. This also ties in to the issue any underlying blockchain faces - that of being able to scale to cope with the volume of transactions, and speed, experienced by fiat currency financial technologies. Stablecoins may also come under regulatory scrutiny quicker than other coins for attempting to behave like fiat currencies, rather than investment assets.Stablecoin adoption and use will depend on their availability across exchanges, their popularity with cryptocurrency users, and their ability to prove adequate reserve backing and less volatile behaviour. It will also depend on the market force of either regulatory pressure, or regulatory approval. Whether one stablecoin emerges as more successful than others, and likely to reach mainstream adoption sooner, remains to be seen.
Buy Bitcoin, Ethereum, XRP, and other cryptocurrencies on Coinsquare, the world's home for cryptocurrency.
[maxbutton id="2"]
