Stablecoins Part 1
Despite the huge potential for blockchain technology to disrupt many sectors of our economy, there are some key aspects which is hindering mass adoption of the technology.
Volatility — the extreme movements in prices — is one key limiting factor. A useful currency should be a medium of exchange, a unit of account and a store of value. However, you cannot be an effective store of value if prices fluctuate significantly on any given day.
We will explore the drivers behind this volatility and explore stablecoins as a potential solution.
What are stablecoins?
Stable coins form a key category of cryptoassets. It is defined as crypto-assets that maintain a stable value against a target price (for example, the US dollar)
In simple terms, anyone who wants to benefit from the advantages of blockchain such as transparency, immutability and security but do not want to lose the trust and stability provided by fiat currencies will require stablecoins.
Stablecoins are primarily designed for two key purposes:
(i) for applications which requires low volatility such as:
- For businesses to accept day-to-day payments
- Recurring payments such as employee salaries and rental
- Remittance to cover price movements while payments are processed
(ii) as a crypto-hedging solution for investors to reduce risk by balancing investment positions in the market or for the purpose of trading and wealth management:
- Act as store of value for long-term hedging
- Creates arbitrage opportunities, exposure to fiat-rates and enables denomination of trading pairs in fiat
Why do we need stablecoins
Stablecoin mitigates volatility. Volatility disrupts the three core functions of money: store of value, medium of exchange and unit of account.
Volatility in the cryptocurrency market has been driven by a combination of
- Rapidly changing public market perception
- Unregulated market with grey areas limiting trust
- A lack of (monetary) policies to mitigate extreme price movements
And yes —while currency is only one of the many applications of blockchain technology, stability is ,however, a key development driver of the entire ecosystem. It forms the basis of a relatively stable cost and incentive mechanism to allow participants to build trust in the system.
In the next session, we will take a deeper look into the three main categories of stablecoins.
Stablecoins Part 2:
You can also check out some great resources on the topic from Consensys (Ethereum development foundation), Bitmex (crypto exchange) and Multicoin Capital (crypto fund investor).
