The Crypto Stability Dream Part I: Understanding Stablecoins
They have been called the holy grail of crypto currencies and have been positioned as the crypto-asset that finally bridges the gap between digital currencies and financial markets. Stablecoins are the latest hottest trend in the cryptocurrency space and one that promises to become an important element of the whole ecosystem.
Yesterday, I found myself in two different conversations about Stablecoins so I’d figure it might be a good idea to write down my thoughts about this new crypto-trend. A lot has been written recently about Stablecoins and their potential role in the cryptocurrency world so I don’t plan to bother you with the basics ;). However, most of the initial content seems to be subjected to the speculation of any nascent and complex technology trend. From my standpoint, there are two main things that should be understood about Stablecoins: what are they? And how do you build one?
Defining Stablecoins
Conceptually, Stablecoins are the ideal crypto-asset that shares most of the benefits of digital currencies and few of the risks. Specifically, Stablecoins came into existing the address the uncontrollable volatility of most digital currencies. While volatility is a great characteristic for speculation, it’s a limitation for the implementation of long term financial products. Most companies or countries won’t conduct large trades in Bitcoin or Ether because of the volatility associated with those assets. Also, even when some people have been able to sell real estate using Bitcoin the proposition remains too risky to be adopted at scale. To put it in more clear terms, the current generation of digital currencies are great vehicles for speculation but not so great stores of value or mediums of exchange.
Stablecoins supposed to be the solution to this dilemma, a cryptocurrency with stable value. Ideally, Stablecoins will have many of the great digital benefits of Bitcoin or Ether without suffering the price volatility. To be a bit more specific, there are four key characteristics that I think should be present on any Stablecoin:
- Price stability
- Scalability
- Privacy
- Decentralization
The first three elements are clearly essential to achieve a stable market behavior but why are we talking about decentralization? Aren’t all cryptocurrencies supposed to be decentralized? Of course they do, but, as we should see soon, some of the requirements of Stablecoins can be conducive to centralization of authority.
The simplest way to think about a Stablecoin is to collateralize its value to another stable asset. However, is that enough to achieve price stability? From the tulip crisis of the 1637 to the recent financial crisis, history taught us that stable assets can also be subjected to speculation. Furthermore, some people might argue that collateralizing a crypto-asset directly challenges the promise of decentralization. As you can see, the answer is not trivial, linking a collateral to a cryptocurrency is an important but not the only way to define a Stablecoin.
The architectures of Stablecoins are directly related to the models used as collaterals which is another way to say that they are related to the different “stable” asset class in the market. The exact architectures for Stablecoins are currently being explored. In my opninion, there are a few models that can be become relevant in the market:
Keep the above chart in mind because we are going to deep dive into each of the specific categories in the next post.
