Stablecoins — What are they actually for?

As stablecoins continue to gain momentum in terms of both market cap and investor interest, it’s important to know what this next generation of cryptocurrencies is hoping to accomplish.

FinTech Weekly
Oct 17, 2018 · 6 min read

by Dean Graham, Digital Content Manager, STASIS

Stablecoin has become a household word for anyone who closely follows cryptocurrency. Tether, the first mover in the stablecoin market, currently has the 8th largest market cap of any cryptocurrency. And with the recent entrance of major players like Circle and a16z into the space, the stablecoins seem poised to play an increasingly large role in the cryptocurrency ecosystem.

A stablecoin is essentially just a digital asset designed to maintain a stable value. Typically, companies try to achieve this stability either by backing the token with collateral in the form of traditional assets or mainstream cryptocurrencies, or by developing algorithms that expand and contract the supply of the token in response to rising or falling prices.

While a price-stable cryptocurrency intuitively sounds like a good thing, it’s worth taking a moment to consider what these projects might actually accomplish if they’re successful in the long run. In other words, what are stablecoins actually for?

In this article, I’ll briefly examine four primary use cases for price-stable cryptocurrency.

Safe haven for investors

During the bitcoin boom of 2017, the most notable group of people in the cryptocurrency market was retail investors. These individuals bought bitcoin as an investment vehicle and rode the 2017 market to immense profits. Even as institutional investors and high net worth individuals are beginning to take on a larger role in the market, retail investors still play a significant role.

At the end of the day, investors all want the same thing: to realize gains on their investment. And not just paper gains — they want to turn their paper profits into money that can be held, spent, or reinvested.

In order to do this, cryptocurrency investors currently have to convert their on-chain holdings back into fiat currency. Otherwise, they’re stuck leaving their wealth exposed to the intense volatility of popular investment coins like bitcoin and ether, where their gains could be wiped out virtually overnight.

There are two main problems with this situation. First, it’s incredibly inefficient. Transferring wealth between cryptocurrency and fiat currency can take days, adds fees for the investors, and usually requires involving another party such as a bank to handle the fiat transactions. Many exchanges don’t even offer crypto/fiat trading pairs, meaning investors have to move their crypto to a different exchange just to trade it for fiat.

Secondly, this system creates a near constant need to move wealth back and forth between crypto and fiat currency as investors enter and exit positions on the market, sectioning off cryptocurrency markets as a realm you only enter to make speculative investments, and not for any sort of utility — an image that would be disastrous for all of the very practical applications being build on the blockchain and utilizing cryptocurrencies.

Stablecoins have the potential to solve both these problems by creating an on-chain asset safe from market volatility. Investors who want to take out profits or exit a bad position can simply exchange their investment holdings for stablecoins until they’re ready to re-enter the market, without ever having to leave the blockchain.

Moving money around the cryptocurrency ecosystem

Exchanges aren’t the only platforms where cryptocurrencies are necessary or useful, and as the industry matures there will likely be a growing need to use cryptocurrencies for purposes beyond just exchange and investment, such as unlocking the services provided by various decentralized applications, or dApps.

In this case, market volatility could be an even greater issue than it is for investors. Investors expect the value of assets to increase and decrease, and can prepare for this by hedging their portfolios. Other applications, such as decentralized newsrooms, games, or social media platforms will need a stable unit of account. Imagine if you know that you’re going to need $100 worth of ETH to use a certain dApp next week, so you go ahead and transfer that money onto the application’s platform, but when you go to use the application a week later you find that the ETH you have available is now only worth $60. At best, this makes using the platform a headache of a process; at worst, it could prevent people from using it at all.

Here again, stablecoins can provide a solution by offering a stable unit of account in crypto-denominated terms. This will help users easily transfer their money between different platforms within the crypto-economy, furthering the development of the ecosystem as a whole.

Everyday exchange

The dream among crypto-enthusiasts is for cryptocurrency to one day be used for everyday purchases of things like coffee, groceries, or new clothes. That dream is still far off, but it’s worth noting that stablecoins are an important step forward. In order for the economy to function efficiently, it needs a stable unit of account for exchanging goods and services. People need to be able to count on most goods and services costing more or less the same today as they did yesterday.

Bitcoin and most other major cryptocurrencies, with their history of wild price fluctuations, don’t meet this need. This creates one of the most significant obstacles to widespread adoption of cryptocurrency as an everyday means of exchanges (though there are certainly others, such as transaction throughput or building the infrastructure for frictionless transactions). Stablecoins, on the other hand, are specifically designed to maintain a stable value. If something costs 1 TUSD or 1 EURS today, it will probably cost the same tomorrow.

Stability for everyone

Finally, a stablecoin use case that isn’t talked about as often, but is nonetheless significant, is expanding access to reliable national currencies. Most of us living in developed nations are used to having a national currency that we can trust to stay relatively stable and provide a safe store of value for our wealth. Looking outside our national currency is a luxury, not an immediate need.

This isn’t the case in many places in the world, where people are somewhat helpless in the face of bad economic policy and a devaluing currency. Turkey is a recent example, and it’s probably not a coincidence that as the value of the lira plummeted in August, bitcoin trading volume in Turkey increased significantly.

However, turning to bitcoin in this situation is half a solution at best. It may allow people to move their wealth away from the control of bad monetary policy, but they’re going from an unreliable currency to an extremely volatile asset. Either way, their wealth isn’t safe from volatility.

Stablecoins can provide a more reliable alternative for people living in nations with bad economic policy by providing access to stable currencies. It may be difficult for people living in these nations to access and hold US dollars, but with reliable internet access they can purchase and hold USD-pegged stablecoins such as TrueUSD. While these coins may not have all the exchange benefits of USD, they still provide a reliable store of value, which is more than either bitcoin or the lira can do right now. In the future, this use case may even move beyond fiat-pegged stablecoins to an independent, algorithmically stabilized currency that isn’t dependent on any national central bank. But first these algo-backed projects must establish the same level of trust afforded to fiat-backed tokens.

Conclusion

This isn’t an exhaustive list. New stablecoin projects are popping up at an extraordinary rate. None of the existing models are perfect: fiat-backed tokens are largely centralized, crypto-backed tokens are still exposed to market volatility, and algo-backed tokens often depend on neverending platform growth. As new models are introduced and new projects develop, people may come up with use cases we haven’t even thought of yet. I hope they do.

But it’s undeniable that stablecoins are playing a growing role in cryptocurrency markets. As you evaluate their impact on the market in general, or consider acquiring a specific stablecoin yourself, it’s important to look beyond their growing market cap and understand what makes them so useful, both now and for the future.

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