Stablecoins 101 — Top Things to Know
Cryptocurrency equals risk. But can it be minimized?
Over the last decade, blockchain technology re-imagined the payment industry ecosystem, creating countless possibilities for ever-growing FinTech industry. Cryptocurrencies are so far one of the most tangible results of this revolution.
However, they are often associated with rather negative keywords, such as ‘volatility’, ‘instability’, ‘risk’, etc. Bitcoin recorded a fall in its value from $20,000 to $6,000 in 2017, all in just two months. No wonder it gave cryptocurrencies some seriously bad press.
Such fluctuations make it unfit for use by most of the business owners and consumers. The solution that many of these people will love is stablecoins. Here are the top things to know about them.
What are stablecoins?
Stablecoins are cryptocurrencies whose prices are pegged to assets in the real world. Theoretically, it is possible to combine them with anything, but most are linked to currencies such as USD or EUR. As a result, the value of stablecoins undergoes only minimal fluctuations, as we observe with the major national currencies.
There are two main types of stablecoins: collateral-backed and algorithmic.
Collateral-backed stablecoins are similar to paper money when it was linked to the gold standard. Just as the cash was supported by the central bank’s gold reserves, the collateral-backed stablecoins are secured 1:1 by the currency reserves to which they are assigned.
Issuers of coins, such as USDC or Tether, ‘tokenize’ dollars, exchanging them for stablecoin and paying money to the bank. These dollars remain untouched until someone buys a stablecoin for dollars. It is certain that stablecoin can be bought out keeping the price.
The second type of stablecoin is one that is not supported by reserves but is controlled by an algorithm. Based on the market behavior, the algorithm issues or withdraws the coins stimulating its supply and demand.
Examples of algorithmic stablecoin in development include, Terra, Carbon, Fragments and DAI.
Why do we need them?
At first glance, the term ‘stable cryptocurrency’ is self-contradictory. Decentralized quasi-money, exchanged without restrictions (such as Bitcoin) will be unstable by nature. The game of demand and supply must lead to value fluctuations. However, it is possible to minimize them.
In the future, countries with a stable currency that decide to introduce their official stablecoin will open the door to an amazing field for development and adaptation at the level of daily transactions. On March 2, the first stablecoin pegged to the Japanese Yen called J-coin was released. Also, the US and Sweden set the first steps in this technology and we can expect more and more governments to join this trend.
Another opportunity is to develop loans using blockchain technology and smart contracts to create derivative instruments, such as derivatives based on stablecoins, market forecasting instruments, etc. Stablecoins could be an ideal tool in hedging against adverse exchange rate fluctuations.
But what else is there for mainstream consumers?
At the beginning of 2019, Facebook blocked advertising of cryptocurrencies. In the opinion of the administrators, many companies mislead potential stakeholders using harmful marketing practices. It turns out, however, that Facebook is not against the idea of using cryptocurrencies. Quite the contrary. Bloomberg reported that the site owned by Mark Zuckerberg covertly develops its own stablecoin solution, which will allow transferring money via WhatsApp. The reason for choosing this, and not another messenger, is very simple. It can encrypt the transmitted content, which, in the case of cryptocurrency, will increase the level of transaction security. Once a solution like this is tested, who knows what other social media companies come up with?
What are the most popular stablecoins?
Tether is a cryptographic version of the US dollar. All Tethers were initially released on the Bitcoin blockchain by the Omni Layer protocol and therefore exist as a cryptocurrency token. Each unit issued for circulation is backed by a one-to-one ratio (ex. 1 Tether = 1 USD) by the corresponding monetary unit in the currency held by Hong Kong Tether Limited.
True USD is another stablecoin that maintains a 1:1 relation with the US dollar. The same moment a True USD is exchanged for dollars (that are stored in a deposit account), the equivalent value of the stablecoin is destroyed.
MakerDAO is a classic example of stablecoins that are supported by other cryptocurrencies and are known as crypto-collateralized stablecoins. MakerDAO started at the beginning of 2017 and offered to establish its stablecoin, known as ‘DAI’ for the US dollar. However, it is not supported by USD, e.g. USDT or TUSD but Ethereum — one of the major cryptocurrencies.
What are the risks?
The risks associated with stablecoins are mainly based on their nature. Those that are closely related to other cryptocurrencies may cease to exist along with their collapse. In turn, those who depend on cash in a bank can lose their value once the account is seized due to AML/KYC laws or other government actions.
The problem is also regulations that would allow or forbid the trade of stablecoins within a given jurisdiction. Cameron and Tayler Winklevoss, the twins who are one of the most popular Bitcoin investors and promoters, anticipate a bright future for the industry. However, they say there is one condition — the market must be properly regulated so that people can see it.
Conclusion
Stablecoins will become more and more popular and will arguably solve many monetary and payment-related issues we face nowadays. What’s more, those with a lower propensity to risk will be finally able to derive benefits from using cryptocurrencies. The technology is, however, still at an early stage. It’s important to experiment with it not to stay behind, being cautious at the same time.
This article is brought to you by Coinquista S. A. — one of the first Polish companies enabling the trade of cryptocurrencies which is listed on the register of small payment institutions authorized by KNF Polish Financial Supervision Authority.
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