Fiat-Pegged Stablecoins as a Stepping Stone to the Next-Generation Global Currency

There is no question that stablecoins are making waves in the sea of cryptocurrencies. Binance research backs up this general sentiment, showing a rise in stablecoin popularity and trading pair usage in 2019. At the moment, fiat-backed stablecoins are flooding the market as a natural transition from our global fiat-driven economy; however, it’s only a matter of time before fiat-backed stablecoins are replaced with algorithmic coins that are better able to retain purchasing power over time.

Our Dependence on Fiat Currencies Could be Dwindling

Entrusting centralized governments and banks with our value has been common practice for centuries, but the digitization of the global economy and introduction of borderless cryptocurrencies is upending this financial order. For one, compared to Wire Transfer or Remittance fees, cryptocurrency is extremely affordable to send and receive. Sending remittances costs an average of 6.84 percent of the total amount being sent. By contrast, sending bitcoin costs as little as 5 cents. People experiencing economic uncertainty in their home countries are adapting by using cryptocurrency as a more predictable store of value, and research by Grayscale shows that interest in cryptocurrencies tends to rise in the midst of economic upheaval, exemplified by such events as Brexit and the US-China trade war. 

Though cryptocurrencies are easier to exchange across borders and can be used as a store of value or means of payment in the event of fiat market failure, cryptocurrencies do not solve for the need for stability.

Enter: Fiat-backed Stablecoins

Stablecoins arose from the need for a stable store of value and way to maintain purchasing power over time. Though the desire to combat volatility in cryptocurrency markets is particularly strong, fiat-driven economies also fall short of retaining value over time. Over the last 25 years, the ten top most-traded fiat currencies have significantly depreciated in value. The US dollar (USD), regarded as one of the most trusted fiat currencies, has lost more than 55% of its purchasing power, while the Euro (EUR) has lost approximately 44% of its purchasing power.

Graph provided by Anchor showing the loss of value over time of the US dollar.

The top five stablecoins by market capitalization are all backed by USD, perhaps due to the dollar’s international familiarity and acceptance as a global currency. Tether (USDT) currently leads the pack with a market capitalization of $3.89 billion. 

Tether’s popularity is likely helped by a constant flurry of news stories⁠—not all of them favorable. Recently, Tether gained attention from the revelation of New York Supreme Court’s order to the New York Office of the Attorney General “to continue their investigation and prosecution of iFinex, the parent company of cryptocurrency exchange Bitfinex and stablecoin issuer Tether.” This news follows doubts regarding Tether’s promised one-to-one backing with USD. Earlier this year, court documents revealed that Tether held enough US dollars in reserve to cover just 74% of all Tether tokens—a far cry from what the Tether website advertises.

Competition Could Change the Game

Whether Tether can survive the continual stream of bad press is an ongoing question, but there is little doubt that stablecoins are only just beginning to pierce the public consciousness. Other stablecoins shifting the conversation include Facebook’s Libra, whose potential for global impact is enormous with estimated total monthly active users thought to exceed 2.4 billion. In August, heavy-hitting crypto player Binance announced the launch of Venus with the goal of developing “localized stablecoins and digital assets pegged to fiat currencies across the globe.” The exchange recently succeeded in launching a dollar-backed stablecoin in the United States, overcoming the same obstacles that Tether’s issuer Bitfinex failed to surmont. Other notable players in the stablecoin landscape include USDCoin, TrueUSD, Paxos, DAI, STATIS EURS, BitUSD, and Gemini (Disclosure: My company, Anchor, recently launched its stablecoin on Liquid). 

Research conducted by Binance found that the majority of top-trading stablecoins experienced net in-flows during the first four months of 2019. The report predicted that Facebook’s Libra and Samsung’s potential development of a stablecoin will only further heighten the value of stablecoins in the public’s eye. Additionally, the report noted that an influx of non-USD stablecoins into the market could evoke such positive impacts as more available channels for global remittance and easier access for people to hedge against currency risk.

Dillon Song, Global Operations Manager at Beijing-operated crypto derivatives exchange BaseFEX, cut to the root of the problem with crypto markets in an interview with Crypto Briefing:

“Bitcoin is the de facto currency in today’s derivative world, but its volatility makes it less suitable for the purpose. When you short BTC using BTC, you lose more than you should since your margin becomes less valuable along the way. Stablecoins could be better than BTC due to their stability. This results in a product that is much easier to use, because it is more predictable, even for sophisticated, professional traders.”

Song is on to something, but fiat-backed stablecoins are not the answer to the crypto market’s volatility.

The Stablecoin Market Will Evolve Beyond Fiat Dependence

Fiat-backed stablecoins are a natural transition for people accustomed to government-backed currencies, but whether these digital coins are pegged to the US dollar, Euro, or Chinese yuan, they will suffer the same market impacts and inflation as their fiat counterparts. A more viable store of value and financial measure would be objective, which is only achievable through the combination of blockchain technology with principles of mathematics and unbiased economic indicators. In other words, fiat-backed stablecoins will inevitably give way to algorithmic stablecoins that successfully retain purchasing power over time through an actually objective peg of value.