Evolution of Fiat Currencies

Taming Crypto’s Fierce Volatility with Stablecoins

Years ago, my grade 10 high school class went on a field trip to the Bank of Canada Museum, and I was thrilled. Housed in the museum, the National Currency Collection is by far the most comprehensive collection of Canadian coins, tokens, and paper money imaginable. It is also where hundreds of samples of international cash and commerce artifacts from throughout human history reside.

That day, my chatty classmates left far behind, what held my attention were the rooms full of collections. Leaning over the displays, I examined the progression and the history of money, from the barter system to commodity trading using scarce materials (like salt and cowrie shells) as mediums of exchange, to precious metals and today’s government-backed fiat currencies.

When we finally left the museum, I came away with a clear understanding that money, in of itself, has no intrinic value. Instead, money (like the playing cards used to pay soldiers in seventeenth and eighteenth century New France) is an object that has a value placed on it. It can be anything, as long as participants agree and pay up.

Covid-19 and the Move to a Cashless Society

In advanced economies, the COVID-19 pandemic sped up an already-declining use of cash. Some stores stopped accepting cash altogether out of fear of transmitting COVID-19 via money. And while the link between cash and transmission was never confirmed, globally, the coronavirus pandemic did cause a surge in demand for contactless payments, accelerating the shift from cash to digital options.

In a 2021 study the Bank for International Settlements reported three key takeaways:

1. The Covid-19 pandemic boosted the use of digital and contactless payments.
2. Cash in circulation reached a decade high due to a surge in demand for high-value banknotes, suggesting that cash was increasingly held as a store of value rather than for making payments.
3. The pandemic added to the motivations of central banks to develop central bank digital currencies (CBDCs).

The pandemic made a marked impact on non-cash payments. In particular, the total value of non-paper-based or digital credit transfers grew strongly in both advanced economies (AEs) and emerging market and developing economies (EMDEs). These payments include transfers initiated via online banking, a mobile banking app or an automated transfer. In addition to the decline in cash payments, the growth in the number of card payments lost momentum or even declined in various jurisdictions suggesting a shift away from cash and cards towards digital credit transfers.

With studies in hand, governments moved swiftly to explore the possibility of issuing a digital form of their fiat, or central bank digital currency (CBDC). Simply put, a digital dollar would be a digital form of the cash in your purse or wallet. Like cash, it could buy the things you need. But the advantage is that you could also use it for online purchases and to transfer money between family, friends and businesses. This new form of money would be issued by a national bank and would provide benefits similar to cash: it would be safe, accessible, and private.

But CBDCs are not cryptocurrencies which, in the case of Bitcoin and Ethereum, can have expensive transaction fees, take a long time to process and allow for limited (if any) recourse if things go wrong. Because they are not pegged or tethered to the dollar, Euro or gold, they are extremely volatile and can fluctuate widely even in intraday trading.

In order to add stability so that cryptocurrency can be used for everyday transactions, the market needed an asset with a store of monetary value for entering and exiting (on and off ramps) decentralized finance ecosystems. The asset also needed to act as a medium of exchange, meaning its value should remain stable over time. It should resist wild price fluctuations that have until now made coins seem largely a speculative investment.

Stablecoins

Stablecoins bridge the worlds of cryptocurrency and everyday fiat currency because their prices are pegged to a reserve asset like the U.S. dollar or gold. This dramatically reduces volatility compared to something like Bitcoin and results in a form of digital money that is better suited to everything from day-to-day commerce to making transfers between exchanges.

There are several types of stablecoins, including:

• Fiat-Collateralized Stablecoins: These stablecoins are backed by a reserve of traditional fiat currency (like USD or EUR) held in a bank. For every stablecoin in circulation, there is an equivalent amount of fiat currency held in reserve. These are the most common types of stablecoins, backed at a 1:1 ratio. In their discussion on stablecoins, Hedera asserts that “though this stablecoin category is the simplest, it is the most centralized, too.”
• Crypto-Collateralized Stablecoins: These stablecoins are backed by a pool of other cryptocurrencies, which are held as collateral. Smart contracts and algorithms manage this collateral to keep the stablecoin’s value stable. The disadvantage of crypto-collateralized stablecoins is their dependency on the collateralized crypto. And like crypto, when unpegged is wildly volatile.
• Non-collateralized Stablecoins: This category uses Seigniorage-style stablecoins to maintain the price stability of a token pegged to an asset. The asset could be U.S. dollars or a real asset like gold. These are algorithmic stablecoins that are non-collateralized. Seigniorage-style stablecoins rely on algorithm-generated smart contracts to supply or sell tokens if the price fluctuates from pegged assets.
• Commodity backed stablecoins: Commodity-backed stablecoins are collateralized using physical assets like precious metals, oil, and real estate. The most popular commodity to be collateralized is gold; Tether Gold (XAUT) and Paxos Gold (PAXG) are two of the most liquid gold-backed stablecoins.

The combination of traditional-asset stability with digital-asset flexibility has proven to be a wildly popular idea. Billions of dollars in value have flowed into stablecoins as they’ve become some of the most popular ways to store and trade value in the crypto ecosystem. There have been many failures along the way and ChainSec has documented all of them. With every unsuccessful attempt, every liquidation, malicious attack, exploit or flawed price stability mechanism, investors’ dreams and many lives were shattered.

Hedera Hashgraph, in its signature conservative style has adopted to partner with Circle, a licensed and regulated financial services company. Circle launched USD Coin (USDC), the next in line stablecoin offering in September 2018. USD Coin is a stablecoin pegged to 1:1 value with the US dollar. The USDC stablecoin is backed by dollar-denominated assets of at least equal fair value to the USDC in circulation in segregated accounts with US regulated financial institutions. Such accounts are attested to (i.e. verified publicly) by an independent accounting firm, making USDC one of the most trusted stablecoins in the digital asset industry.

According to DataWallet, “USDC complies with all anti-money laundering and know-your-customer regulations, ensuring the highest level of security for users. With these measures in place, USDC is one of the safest stablecoins available on the market today.”

Tether was under heavy speculation, which led to a rise in other US dollar-backed stablecoins that are transparent and audited. USDC is both regulated and audited and works almost similarly to Tether. Hedera Hashgraph

The purpose of a stablecoin goes beyond being just a financial contract. It is the evolution of both conventional payment systems and traditional, volatile cryptocurrencies. They offer a step forward in bridging the gap between standard payment systems and the volatile realm of traditional cryptocurrencies. They essentially bring a new type of digital currency that is handled algorithmically rather than by a central authority, while providing similar financial benefits to fiat currencies. Stablecoins, as fundamentally stable assets, have the ability to bring in widespread adoption of digital assets in everyday transactions.

Use Cases:

Stablecoins have a wide range of use cases:

Trading and Investments: Traders often use stablecoins as a safe haven during times of high cryptocurrency price volatility. They can quickly move their funds into stablecoins to protect against losses.

Remittances: Stablecoins enable fast and low-cost cross-border transactions, making them an excellent option for international money transfers.

DeFi: Stablecoins are a fundamental part of the DeFi ecosystem, where they are used for lending, borrowing, liquidity provision, and more.

Tokenization: Stablecoins can represent real-world assets on the blockchain, allowing for fractional ownership of assets like real estate or stocks.

Governments and regulatory bodies are increasingly paying attention to stablecoins due to concerns about money laundering, fraud, and financial stability. Some countries like the U.S. are actively working on regulations to oversee stablecoin operations. Stablecoins offer the benefits of cryptocurrencies (speed, transparency, security) while minimizing the price volatility that can make traditional cryptocurrencies less practical for everyday use. And while there are still some risks associated with stablecoins, with regulatory certainty, stablecoins will continue to evolve, and gain public trust.

Hedera Stablecoin Studio

On September 13, 2023 at Token 2049 in Singapore, Hedera announced that Stablecoin Studio, an open source software development kit (SDK), is now available on the Hedera network.

The SDK is a comprehensive set of tools and resources including CLI streamline smart contract interactions, documentation, and sample codes to help developers understand how to use the project and other advanced functionalities provided by the platform.

With Stablecoin Studio, enterprises, banks or institutions can easily issue, manage, configure Stablecoins, add on-chain KYC/AML capabilities and make use of the one of a kind Proof of Reserve feature native to Hedera. Seasoned cryptocurrency developers or newbies to the space can find everything needed to start building with stablecoins with a few lines of code. The easy to use kit accelerates development and streamlines operations without specialized blockchain expertise.

We are already seeing a wave of adoption coming to Hedera from well-known banks such as Shinhan Bank of South Korea, Standard Bank of South Africa, Cathay Bank of Taiwan, and SCBX Bank of Thailand, which have utilized Hedera native stablecoins for their initial cross-border remittance POCs. Another noteworthy example is the Worldpay FIS announcement, again at Token 2049, about the introduction of a Proof of Reserve service for their institutional partners, fully built on Hedera.

By entering the stablecoin market with a robust all-in-one solution, Stablecoin Studio on Hedera might very well serve as a catalyst for rapid network expansion over the course of the coming year. And Citadel Wallet will be there, supporting users’ journey into a fully decentralized future.

Citadel Wallet Announcement:

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