Not All Stablecoins Are Created Equal

Stablecoins could prove to be the first cryptocurrencies to achieve mass adoption.

A growing number of crypto experts are beginning to look towards stablecoins as a remedy for one of the biggest problems that has plagued the cryptocurrency space — instability. While stablecoins appear to hold a great deal of promise in curtailing that shortcoming, there are important distinctions to be drawn, because not all stablecoins are created equal.

For the benefit of anyone not familiar with the term, a stablecoin can be defined as “an asset that promotes price stability, by which it can serve as a medium of exchange and a store of value.”

Unfortunately, the vast majority of coins and tokens experience significant swings in price, rendering them unsuitable to perform any of the aforementioned functions. Even the best known coins — Bitcoin, Ethereum, Ripple — have all seen gyrations in their prices, with swings of 5%, 10%, or more in a single day. No coin or token that has the potential for such violent movements can ever serve as an everyday currency.

Enter the stablecoin. One characteristic of most stablecoins is that they are collateralized, or backed, by something of value or, at least, perceived value. Let’s take a look at some of the more popular methods employed by the creators of stablecoins.

• Gold backed stablecoins: There are several stablecoins that are backed by either physical gold or gold derivatives. Sounds great, right? I mean, in the days of the gold standard, most world currencies were backed by gold. There is a glaring difference between the days of old and today, however. During the gold standard era, the price of the shiny commodity was set at $35 an ounce by the government. Its price was static and therefore stable. The problem is that now, gold is traded on the world market and its price can fluctuate, often significantly. This makes the underlying currency subject to the volatility experienced by its collateral, in this case, gold.
• Fiat backed stablecoins: Various coins and tokens have been created which are linked to fiat currencies in an attempt to provide stability. One of the biggest, Tether, has a 1–1 relationship to the U.S. Dollar. Surely this is the answer, isn’t it? Well, not so fast. Unfortunately, fiat currencies all have one thing in common, and that is a built-in inflation. Central bankers around the world manipulate interest rates and their currencies to ensure a small, but omnipresent, rate of inflation. You can probably guess what that means for stablecoins pegged to fiat currencies. Yes, inflation erodes their value over time and thus their underlying crypto asset can never serve as a store of value.
• Crypto backed stablecoins: These are cryptocurrencies which have other cryptocurrencies to back the original cryptocurrencies. The problem here should be obvious; how can an unstable collateral make its underlying asset stable? Well, it can’t. And that’s the problem in a nutshell. Something that is inherently unstable can’t be used to make anything else stable. There is no “two unstables = a stable” equation. This appears evident on its face, so, caveat investor.
• Financial instrument backed stablecoins: This is a relatively new and promising development on the stablecoin front. The collateral which backs the cryptocurrency consists not of gold, fiat, or other crypto, but of financial instruments such as corporate bonds, municipal bonds, treasuries, etc. The theory behind an FI backed currency is that the collateral is not only stable, but income producing. This will ensure that not only the underlying asset will be kept stable, but that it will actually keep pace with inflation. The correct balance can provide not only the necessary stability function, but also the viability to be used as a medium of exchange and the ability to serve as a store of value — finally, a stablecoin trifecta.

Nobody can predict with any certainty which type of stablecoin will emerge as the standard, but it is almost a sure thing that stablecoins will play a large role in the future viability of cryptocurrencies as a whole.

Don Bielak is the CEO of Monetran, LLC, an internet fintech company which is being built on the Stellar network. Among his team’s developments is Moneda, a redeemable stable token which is backed by financial instruments. Information on Monetran can be found on www.monetran.com and the company’s SEC Regulation Crowdfunding info is at www.startengine.com.