A Stablecoin – What are they and Can It Even Be Done?

Conor Maloney

June 8, 2018

The cryptomarket is full of stablecoins that aren’t… well, they’re not very stable

Volatile by nature, the market attracts people looking to capitalize on the wild upswings and downward trends seen in the space of hours, minutes, and seconds on the market every day that would make world headlines in the traditional financial markets.

The market cap of all cryptocurrencies is currently $345 billion. That’s a lot of money, but it’s dwarfed by the market cap of the stocks on the New York Stock Exchange which are worth almost $20 trillion.

Comparatively fewer traders means the market can be more easily influenced (or manipulated) and the price action can be notoriously skittish. Things can go very bad, very fast for people investing large amounts of money in day or swing trading, and the way some exchanges work, by the time a trader who sees a storm coming succeeds in cashing out their investment to fiat they might have pretty much lost everything, either eating the loss or being left holding the bags in the hopes that eventually the value will increase.

There have been horror stories about exchanges completely halting fiat withdrawals during periods where the whole market was going down. BitGrail famously only allowed fiat withdrawals during very narrow windows at inconvenient times for many users in the weeks preceeding the RaiBlocks/NANO loss of 15 million tokens worth about $150 at the time.

Does The Market Need Stablecoins?

In short, yes, and there are a number of reasons.

While price swings appeal to traders, cryptocurrency is more than just lambos and moon rockets (I know, I’m as shocked to learn this as you are). The technology allowing people to transact freely, instantly, and peer to peer across international borders is amazing and has huge social, political, and industrial implications. Using cryptocurrencies as actual currencies would be great, but mainstream adoption is being held back by intimidating price volatility.

People receiving wages in fiat currency often have to wait days to carry out transfers – getting paid in crypto would be great if it was possible to guarantee that the value wouldn’t dissappear overnight, and if it was possible to spend the cryptocuurrency in stores, and the implementation of a real stablecoin would help that process immensely.

Even for those more interested in the lambo side of things, it would certainly make things easier, right? A cryptocurrency with a fixed value (most projects working on it peg the value to $1 USD) that can be transferrred instantly. Users trading Bitcoin, for example, can buy in when the price is relatively low, watch it rise (hopefully), and when they feel they’re ready to cash out or they see the price falling, they can immediately cash out into a stablecoin and either cash out into fiat or hang onto it until they see an opportunity to buy back in. Timing is important, of course.

It’s the next best thing to actually allowing fiat trading pairs – or it would be if it worked, that is.

For money to qualify as money, it needs to be a medium of exchange, a store of value, and a unit of account, and a stablecoin needs to have those properties as well.

There are a number of stablecoins currently on the market and in development, but the big players in the space at the moment have thier flaws. The top dog is Tether.

I’ve written before about this cryptocurrency in an article entitled “Can We Trust Tether?

It’s worth a read in its own right for all the juicy scandals, but for now if you just want to know the answer…

No. You can not trust Tether.

Essentially the company has refused to release their  bank statements or what bank they’re working with, and fired the auditor they hired to demonstrate to the public that the project was legitimate before the auditor could finish their job. The reason? They said they were “too thorough.”

What’s the alternative? To get into stablecoins and why some of them aren’t up to scratch, we need to know how they work.

How Do Stablecoins Work?

Take your average crpytocurrency: If people suddenly start buying more of it, sellers start to slightly increase the price, often leading to a domino effect and crazy price swings that day traders make their living off of. It’s not uncommon for currencies to see a ten or fifteen percent price fluctutation in one day, something that would give stock traders a heart attack in the traditional markets.

With a stablecoin, the last thing you want is for your coin to move. If something goes wrong in the market, people will suddenly start buying more of the stablecoin, but it can’t change in value, that’s the thing. Market laws would usually dictate that slight increase in price happening immediately, but not here – the coin can’t budge or it doesn’t work. The USD has an inflation rate of around 2 – 3% which is much more manageable than crypto inflation/deflation.

To achieve this, stablecoins are backed by outside assets. Here are the three main strategies:

Fiat-collaterized: Stablecoin projects pegged to the value of $1 USD actually have $1 USD for each token. Tether claims to be fiat collateralized, but have refused to present evidence. TrueUSD are Tether’s main competitor, but the token didn’t have enough liquidity to remain stable after launch and ended up trading at $1.39 after being listed on Binance.

Not very stable!

Crypto-collateralized: This is what it sounds like – the currency is pegged to the value of another cryptocurrency. Maker, for example, is backed by Ether. The downsides of this are that it’s slow, complicated to maintain, and of course reliant on the continued existence of Ether as a valued asset. It is however a decentralized and transparent project, unlike competitors like Tether.

Non-collateralized: These tokens aren’t backed by anything, and instead use smart-contract-released algorithms to restrict or expand the supply to counter price fluctuation, much like a central bank does with fiat.

Coins are often pegged to the value USD or the value of gold, but it’s worth noting that other projects are commodity-collateralized as well.  Vault, for example, are collateralizing the value of their token with gold –  the token will be pegged to the USD but backed by gold bullion extracted by the company’s established gold mining operations, a commodity-collateralized solution that may prove promising.

How does it remain stable?

Smart contracts on the blockchain issue commands based on the data received that restrict or expand the supply of the currency, much like a central bank does with fiat currency (but on a blockchain, because blockchains make everything better, am I right?)

While many projects are centralized, which to some defeats the purpose of cryptocurrency, others are decentralized and operate purely on pre-programmed smart contracts. It remains to be seen how the stablecoin experiment will work out and which method will end up being the most succesful, but one thing is for sure – the closer we get to introducing a trustworthy stablecoin to the market, the closer we get to mainstream adoption, which is great for idealists and moon-bound lambo enthusiasts alike.

remember: Crypto is coming!

Interested in other cool crypto posts….check out Mining Wars: Bitmain vs Dragonmint and The Price of Bitcoin vs Cost of Mining.

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