Stablecoins

Richard Slenker
Feb 5, 2019 · 6 min read

An overview of stablecoins and their role in the new digital financial ecosystem.

Image for post
Image for post

What are stablecoins?

Why use cryptocurrencies?

Cryptocurrencies aren’t sufficient?

How do stablecoins solve this problem?

  • A digital token with price stability gives investors the opportunity to interact with the digital ecosystem while avoiding the middlemen’s costly conversions between fiat and crypto. The investment experience can remain entirely digital.
  • Fiat currencies’ inherent benefit also applies to stablecoins: the stability of the US Dollar or another asset/currency to which it is linked. Countries with weaker or volatile fiat currencies could utilize stablecoins similar to embracing the USD to manage risk and participate in global monetary systems.
  • Cryptocurrencies’ inherent benefit applies to stablecoins: fast and trustless settlement, frictionless transfer, and use of blockchain technology.
Image for post
Image for post
Source CMC

Collateralized Stablecoins

Example: TUSD, GUSD, USDC, PAX, USDT

  • Fiat-backed stablecoins are issued in accordance to a set ratio pegged to fiat currency. The total amount of tokens issued must be 1:1 with the total cash in the bank or vault. For example, the USD Coin (USDC) is pegged 1:1 to the US Dollar. This stabilization method presents risks around the trust of centralized third parties. These fiat custodians are audited frequently to prove that the digital tokens are fully backed by fiat deposits.

Asset-backed

Example: Digix

  • The structure of asset-backed stablecoins is similar to fiat-backed, however, the digital coin is pegged to the value of a hard asset instead of a fiat currency. For example, Digix offers a token, DGX, where one token is equal to one gram of gold. This gold is stored in a vault in Singapore and is audited quarterly to ensure the gold reserves correlate to the total market cap of the token.
  • The risks associated with asset-backed stablecoins are similar to the risks of fiat-backed stablecoins in that third parties must be trusted with audits to ensure the peg ratio holds true.

Crypto-backed

Example: DAI

  • Crypto-backed stablecoins are digital tokens that are backed by the value of another digital asset like Bitcoin or ETH. This structure is a bit more complicated as the price of cryptocurrencies can swing wildly; thus simply pegging the two assets, Ether and the stablecoin, 1:1 will not serve to stabilize the price. Thus, more creative solutions, like that of MakerDAO and their stablecoin DAI, have been introduced. Maker uses collateral debt positions (CDP) which operate similar to a bank. Smart contracts on Ethereum hold collateral in ETH and in return give a “loan” of 66% of DAI. If the value of ETH goes below a certain threshold, the user either pays back the CDP, or the position is auctioned to the highest bidder.
  • Currency risk exists in this initial deployment of CDPs due to lack of diversification of a single digital asset, ETH, held as collateral. Future developments of the CDP functionality will allow the smart contracts to hold multiple asset types thereby increasing diversification and reducing volatility.

Non-collateralized Stablecoins

Example: Basis

  • Algorithmic stablecoins are not backed by a hard asset, but instead automated logic modifies the token supply based on supply and demand. Think of this as an automated central bank that enacts monetary policy through programmatic capital controls.
  • User adoption is one risk faced by algorithmic stablecoins, like Basis, since the functionality of the system required participation for stability.
Image for post
Image for post

What do stablecoins enable?

  • Greater access to the global financial system: anyone with internet access can gain exposure to stablecoins.
  • Stablecoins are poised to be a powerful vehicle for fundamental long-term changes in the global economy: decentralized stablecoins transcend economic controls and policies.
  • Intersection of stablecoins and tokenized securities: investments and dividends become practical.
  • Programmability: payments via stablecoin are not subject to the volatility of cryptocurrencies.

What comes next?

The next generation of currency should allow alternative pegging so that they can be shielded from extraordinary events. Ideally, it should be backed by a diversified uncorrelated basket of assets to avoid effects of such events. Additionally, an ideal stablecoin would execute smart contract logic on-chain and be backed by decentralized assets. Each of the first attempts highlighted above successfully accomplish essential tasks in this development. With certainty, the next evolution in stablecoins is coming.

Learn more about Fluidity Factora.

Watch Crypto Bobby’s recent livestream on stablecoins.

Special thanks to Mel Higgins, Deepa Sathaye, Todd Lippiatt, and Michael Oved for providing feedback on this article.

¹Ethereum is a blockchain that provides infrastructure enabling smart contracts.

² Smart contracts are protocols that enable trustless transactions without the need for a central third party.

About Fluidity

Fluidity

Rebuilding Finance for a Frictionless World

Medium is an open platform where 170 million readers come to find insightful and dynamic thinking. Here, expert and undiscovered voices alike dive into the heart of any topic and bring new ideas to the surface. Learn more

Follow the writers, publications, and topics that matter to you, and you’ll see them on your homepage and in your inbox. Explore

If you have a story to tell, knowledge to share, or a perspective to offer — welcome home. It’s easy and free to post your thinking on any topic. Write on Medium

Get the Medium app

A button that says 'Download on the App Store', and if clicked it will lead you to the iOS App store
A button that says 'Get it on, Google Play', and if clicked it will lead you to the Google Play store