Everything You Ever Wondered About Stablecoins

Stablecoins are digital currencies developed to minimize the volatility of the price of set stable coin. Stablecoins can be pegged to fiat currency, like the US Dollar, another cryptocurrency, like USDT, or to exchange traded commodities, like precious metals. As such, stablecoins are not intended as an investment vehicle, but rather a safeguard towards the underlying value of the pegged asset (b.g. US Dollar, gold, USDT).

The Bitcoin and cryptocurrency market cap has been quite volatile ever since the initiation of the Bitcoin Genesis block, back in 2009. In its ten-year odyssey, the market has gone through a few bumpy market cycles.

Bitcoin broker fees can add up, especially when you are entering in and out of investments at a fast pace.

Buying and selling real-world items with Bitcoin still has its setbacks, when you look at the number one cryptocurrency from an investment perspective, because Bitcoin might be worth a fortune in the future and you end up like Laszlo Hanyecz, who paid 10,000 BTC for two pizza’s which is now, ten years later, the equivalent of $70,000,000. 

Stablecoins are digital currencies developed to minimize the volatility of the price of set stable coin. Stablecoins can be pegged to fiat currency, like the US Dollar, another cryptocurrency, like USDT, or to exchange traded commodities, like precious metals.

As such, stablecoins are not intended as an investment vehicle, but rather a safeguard towards the underlying value of the pegged asset (b.g. US Dollar, gold, USDT).

The history of stablecoins

Back in 2014, Steem and EOS founder, Dan Larimer launched BitShares, the first stable cryptocurrency project, to provide investors with a safe hedge against the highly volatile cryptocurrency price swings. Nubits launched USNBT in that same year. 

Moving forward to 2015, RealCoin was introduced, which has since rebranded to Tether, the coin most people know, either because it is available for trading at all the major exchanges or for its controversy and pending legal action initiated by the US government.

Tether is built on the OMNI blockchain and has been a stablecoin market leader since 2015. In 2019, Tether started mitigating from OMNI to the Ethereum blockchain.

In 2016, USNBT lost its peg against the US Dollar.

Steemit introduced SteemDollar (SBD), to stabilize the rewards system on social blockchain platform Steemit. SBD pegged 1:1 to USD. In December of 2017, SBD reaches its all-time high price of $13.81. Currently trading at $0.69 (during the blood-bath of March 12).

Tether (USDT) allegations started to surface in 2017, where, rumor has it, Tether isn’t fully backed 1:1 with the USD. Only recently Tether representatives admitted the stablecoin is only backed by around 74% making it a fractional reserve stablecoin.

Bitfinex, the company behind Tether reports an $850 million loss in Tether funds that they plan to supplement by using funds they raised for its new asset exchange token LEO.

Over the past few years, stablecoins have been a trending topic in the cryptocurrency industry, with a peak in 2019. Comparing the data, in March of 2018, Tether was the only stablecoin in the market cap top 30, while in March 2019, there were 3 stablecoins or stablecoin projects in the top 30. Recently we have 2 stablecoins in the cryptocurrency marketcap top 30. 

In 2019 a lot of “Tether-Killers” emerged, but there has not been a project able to dethrone the company behind USDT. 

What is a stablecoin?

A stablecoin is a cryptocurrency pegged to a stable asset, which is most often the US Dollar, but it can also be pegged to gold, other fiat currencies or cryptocurrencies.

Pegging the value against the US Dollar might seem strange as the value of the US Dollar isn’t fiduciary anymore. While a commodity doesn’t back the US Dollar, the value has remained semi-stable over the last decade, so it seems a favorable option to be backing a stablecoin.

An ideal stablecoin is fungible, meaning it acts as a medium of exchange, a store of value, and a unit of account. A recurring fundamental base for stablecoins is that they hold their specific value against their peg, and fluctuations are minimal.

Currently, the fluctuations for the stablecoins with the highest valuations do not exceed the 3% mark.

What are the benefits of stablecoins?

Reducing price volatility

If at some point in the future, the tokenization of real estate, art, collectibles or assets reaches mainstream adoption, high-volatility in the prices of widely used cryptocurrencies is not an option. A solution can be using a stablecoin for transactions.

Recently, Blockimmo, a real estate company focused on tokenizing real estate, initiated an online property sale, where investors could buy a piece of the building. Blockimmo used XCHF, a stablecoin version of the Swiss Franc (CHF) as a payment option, keeping the price steady during the entire transaction process. The XCHF has a peg of 1:1 to the Swiss Franc (CHF).

Hedge

A stablecoin can offer a safe hedge against fiat currency in countries with challenging economic conditions. This does not work if the fiat currency is the Dollar.

Remittance market

Paying a family member, that resides on another continent, or transferring a business payment to an international customer, most commonly is done through a bank, PayPal or Western Union. Downsides to these mediums of exchange can be the timeframe, security, or the costs. Cryptocurrencies solve this to a certain point.

The price can fluctuate between the moment of purchase and the actual transaction. Using a stablecoin for the remittance market solves the issue of price fluctuations as well as gives the added benefits of time and cost efficient and secure.

dApps

Using a stablecoin for in-app purchases can be perceived as a better option than using a utility token that is either low in volume, volatile in price or a combination of both.

What types of stablecoins are there?

Three types of stablecoins are generally grouped:

Fiat collateralized

These types of coins are fully backed by fiat, which is mostly the USD. For each stablecoin, one dollar is locked away as collateral in reserve. Most of the stablecoin projects are being monitored and audited by specialty firms with a good track record.

A commodity collateralized stablecoin functions roughly the same as a fiat collateralized stablecoin. The main difference is it is backed by gold, silver or another precious metal or commodity.

An example of a commodity collateralized stablecoin is DigixDao, which is backed by gold.

Crypto collateralized

Stablecoins that are crypto collateralized have specific cryptocurrency in a reserve fund to back the coin. Because of the volatile price action of cryptocurrency, the peg ratio isn’t 1:1, but it is kept higher to cover large price swings.

An example of a crypto collateralized stablecoin is MakerDAO’s DAI coin.

Non-collateralized / algorithm backed

A non-collateralized stablecoin functions similar to a central bank. In essence, fiat money keeps its stable value, because the central bank is monitoring the asks and demands. If the asks for fiat go up in amount, the central bank prints new money, hence more money in circulation that supplies the asks for that money, keeping the price steady.

When the demand decreases central banks step in and buy back fiat money to keep in the reserves, hence money out of circulation.

Reserve Protocol has launched a stable and decentralized currency, specifically designed to reduce financial instability in countries with a high inflation rate. Reserve will launch a pilot in Venezuela and Angola, two countries facing economic turmoil.

Stablecoin trends and developments

The 2019 surge in the creation of new stablecoins, led by digital asset exchanges, like Gemini, Circle (Poloniex) and Digitex, put stablecoins back on the map and raised discussions about the benefits and drawbacks of using a stable coin on a large scale.

One of the oldest and the biggest stablecoins, initiated by an exchange, in terms of volume and market capitalization at the moment is Tether. Tether endured some scrutiny over the years, and it seems like its reaching its pinnacle soon.

The digital asset exchange stablecoin

Global financial service providers, in the digital asset industry, like OKCoin (USDK), Huobi Group (HUSD) and Binance (BUSD), have all launched a stablecoin. The coins are tradeable at their parent company’s asset exchanges as well as other platforms that list an array of stablecoins. 

USDK, HUSD, and BUSD are all based on the Ethereum blockchain, issued as an ERC20 token, is pegged 1:1 to the US Dollar. 

Tether the first fractional reserved stablecoin

Bitfinex and Tether are under discussion regarding the reserve funds, either fully backing USDT or not. Legal documents state that the stablecoin is only backed by 74% by US Dollar. Hence, there is not enough currency in the reserve fund to ensure all token holders can convert their USDT to US Dollar.

Tether terms were also adjusted, stating that token holders are not guaranteed a conversion of one USDT for one US Dollar. Digital asset exchange Digifinex has announced it is favoring Trust Token’s TrueUSD over Tether and has listed TUSD to replace USDT.

Bank-issued stablecoin

JP Morgen introduced JPM coin as a solution to improving international payment settlements. By using JPM coin, large institutional clients, transferring significant sums of money, will see the transactions executed, faster, more secure at a lower cost.

Facebook

Facebook is creating a stablecoin to be used on messaging platform WhatsApp. It will be called Libra Coin. They have set up shop (the Libra Association) in crypto-friendly Switzerland to continue the development of what will be a dollar-backed digital currency for in-app payment transfers.

Initially, the Libra Association announced some large global payment providers like Mastercard, Paypal, Visa, PayU and Stripe as its founding members. Over time, many founding partners (Visa, PayPal and Stripe) revoked their membership. Recently the association added Shopify and crypto broker Tagomi as their newest partners. 

There is no set release date for the launch of Libra. Originally, Facebook planned to launch Libra in 2020, but it seems that this is no longer achievable.

XRP-backed stablecoin

In May 2019, news emerged that Kava Labs started creating an XRP-backed stablecoin, called USDX. Kava Labs is backed by Ripple’s initiative Xpring.

The stablecoin as a central bank digital currency (CBDC)

Central banks around the world are exploring cryptocurrency as an official payment gateway. As we are moving towards a cashless society, real-world adoption for digital currency doesn’t seem too far out of reach.

The Republic of the Marshall Islands is creating the Sovereign (SOV), a fully compliant digital currency that will be legal tender on the small Pacific Island. The plan is to issue SOV, in addition to the USD, which is an official fiat payment solution in the Marshall Islands.

The Swedish central bank, Riksbank, is also pretty far along in doing research on launching the e-Krona, a digital form of the fiat currency the Krona.

The Public Bank of China (PBOC) has been researching and unofficially developing a digital version of the renminbi since 2014.

Read more about it in my article about central bank digital currency on Hackernoon:
 https://hackernoon.com/the-future-of-central-bank-digital-currency-cbdc-64797b645887

Stablecoin overview

It is nearly impossible to write about all the different stablecoins projects in one single article, as there are over 57 different ones at the moment. Some of them have already launched, while others are in the development stage. The six stablecoins that have the highest market cap will be briefly discussed.

Tether (USDT)

The most well-known stablecoin is probably Tether or USDT as its ticker goes. Tether has been around since 2015 and has been added to many exchanges as a separate trading pair that can be transferred against most mainstream cryptocurrencies.

USD Coin

Launched by Circle, the parent company of Poloniex, USD Coin (USDC) is a fiat backed stablecoin pegged to the US Dollar. It runs as an ERC20 token on the Ethereum blockchain.

Gemini Dollar (GUSD)

The Gemini Dollar is a project related to digital asset exchange Gemini, which is founded by the Winklevoss twins. A New York regulator from the New York Department of Financial Services (NYDFS) approved this USD-backed stablecoin, called GUSD.

Paxos (PAX)

PAX is a stablecoin introduced in September of 2018. PAX is one of the stablecoins that is officially approved by the New York Department of Financial Services (NYDFS), like Gemini’s GUSD. Paxos started the process to migrate to Ontology’s OEP4 standard, from Ethereum’s ERC20. This partnership will help Ontology execute atomic swaps with a more stable unit.

TrueUSD (TUSD)

TrustToken launched TUSD as an alternative to USDT. USD-backed stablecoin that is 100% collateralized by USD in legally protected escrow accounts.

MakerDAO (DAI)

MakerDAO created the DAI stablecoin. DAI is an asset-backed, decentralized currency that runs on the Ethereum blockchain.

Stablecoin drawbacks

Anonymity

Official companies behind stablecoin projects need to be compliant with governmental authorities. This enables a lack of anonymity because customers need to go through a KYC/AML process before they can buy a stablecoin. In some countries, it is difficult to buy a stablecoin directly with your bank account.

Centralization

Centralization all backed by a central authority similar to traditional financial institutions like banks. There is a risk that the custodian is going bankrupt. This single point of failure is not what blockchain is about.

Hyperinflation

If a stablecoin is pegged to the USD and that coin faces hyperinflation then so does the stablecoin.

Necessity

As with all assets, over time, markets tend to decrease in price volatility. If Bitcoin and other cryptocurrencies stay relatively stable in price, the need for a stablecoin might no longer be there. This decrease in volatility, however, can still be years away.

Concluding remarks

As history showed us, only one stablecoin has officially kept its dollar-peg for a continuous number of years. Despite the news that indicates only 74% of USDT are fully backed by reserves. And that same stablecoin is currently under investigation by the US authorities.

While I believe a stablecoin can be a solution to help struggling economies and protect traders against cryptocurrency price volatility, in essence, they are just ‘crypto’ banks with centralized authorities, and it is not yet moving us towards a world of decentralized autonomous organizations.

Full disclosure: This article is not intended as investment advice. It is just my personal opinion about stablecoins. You should always do your own research, before investing in a project and never invest more than you are willing to lose. 

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 LindaCrypto