The Importance of a Stablecoin

By Lucia Ziyuan

In the wild world of cryptocurrencies, extreme volatility shocks no one. This week right after BTC reached a historic high of over $5000 on Sep 02, a downward swing sets the price back by $600, echoing a steep price dip across 10 cryptocurrencies including ethereum (down by 14.53%) and litecoin (down by 15.37%).

BTC price movement in a single day. Source: CoinDesk

Whether the 13 billion bloodshed across crypto market is due to investors’ concern over BTC roadmap following the Chinese ICO ban or a speculator move for manipulate market expectations, we know one thing for sure: the cryptocurrency market is very far from stable.

Although there are many benefits of cryptocurrencies — low transition cost, expansive cross-border reach, autonomy provided by little governance, to name a few — their lack of stability is a serious hurdle to act as a strong contender for central bank money.

Is it possible to build a stable crypto economy? Can we build a stable coin that could weather the storm of wild crypto market speculations?

What is a stablecoin?

The people behind Dai Stablecoin once stated in this wiki page that stable coin is a “cryptocurrency with price stability” for short and mid term use as “unit of account”. Over the long run stable coin should be able to serve as “store of value” during market down turn, much like how traditional “safe haven” assets would perform.

While this wiki definition is slightly out of date now, the general principles defined here still hold true. The main attribute of stablecoin is its price stability over mid or even long term despite market turbulence. This would require stable coin to have value independent from the trading markets.

Gold, for example, is a classic safe haven asset whose price performance is somewhat independent from stock or equities market, and its price cannot be manipulated by central bank controlled interest rate.

US dollar has been considered a safe haven asset, but as a currency it’s subject asset bubbles and inflation created by the central bank, such as when Feb decided to add $4 trillion supply for “quantitative easing”.

Gold and US dollars are traditionally perceived as stable assets. Image source

Currently stablecoins in the crypto world are backed some form of collateral to achieve stability in value. There are USD-backed stablecoin such as Tether, gold-backed stablecoin such as DGX, and ETH-backed stablecoin such as Dai. Other experimental thoughts on stabilising cryptocurrency include Seigniorage Shares where the supply of coins will decrease over time instead of increases.

To build a stable decentralised economy, we need stablecoins that behave more like Gold in that it does not need any government to establish its value. The problem with USD-backed or any FIAT money backed cryptocurrency is that it’s still doesn’t have any physical reserve behind it therefore has only “face value” that is subject to inflation and financial crisis.

Stablecoin Beyond Means of Payment

There are many use cases for stablecoins with intrinsic value. In the payment landscape, a stablecoin like DGX can be integrated for credit card payments.

Tenx / Digix Gold Debit Card

DigixGlobal partnered with TenX to roll out the first ever gold-backed debit card. Image source

What’s really exciting about stablecoin is their ability to act as collateral for term loans, which requires assets relatively stable in value for the loan to be secure. DGX, for example, has stable value pegged to LBMA gold price, and can be safely priced over 6 months period or longer.

Looking into the future when stablecoins are more widely accepted and used, they can be used as a reserve asset on cryptocurrency exchanges. Many of the biggest bitcoin exchanges such as Coinbase are by nature centralized. They can be vulnerable to attacks, and are known to freeze user accounts or cancel transactions due to “security concern”.

With stablecoin such as DGX, it will enable peer-to-peer swaps and therefore create a truly decentralized economy.