USDT delisting is fake news, but stablecoins still have a long way to go

Monday, the 15th of October, a news circulated in the crypto markets that the poplar exchange of Binance was about to delist Tether (USDT) from its platform. It turned out to be a fake news, but the damage had been done in the crypto markets. USDT owns the biggest market share of stablecoins. Many readers are probably not familiar with stablecoins, and we would love to make some introductions.

1. Birth and status quo

The demand for stablecoin comes from the large fluctuations in the prices of other cryptocurrencies. Although Bitcoin and Ethereum have brought huge returns to investors in the past few years, the fluctuations of their prices against fiats have left many people discouraged. High volatility is also making it difficult for mainstream cryptocurrencies to be used in the real world. At this time, we need a cryptocurrency with relatively stable value to connect the world of cryptocurrency and fiats. Stablecoins were born under this circumstance.

The biggest difference between stablecoin and other cryptocurrencies is that stablecoins’ prices are relatively stable. Most stablecoins in the market are pegged to fiats. USDT, the first stablecoin issued by Tether Limited, was formed by Bitfinex in 2014. Then a variety of stable coins have been produced. The market size of the stablecoins is currently around 3.1 billion US dollars. USDT, which has a market capitalization of about 2.8 billion US dollars, accounts for 90% of the whole stablecoin market. The table below shows the list of stablecoins on the market as of October 22, 2018.

Recently, 15 institutions launched 13 stablecoins within 30 days. Most of stablecoins are pegged to US dollar. It is worth noting that two stablecoins are endorsed by the government — Gemini Dollar (GUSD) and Paxos (PAX).

2. Defects of stablecoins

1) Design and implementation

There are three fundamental approaches to designing stablecoins: centralized IOU issuance, collateral backed, and seigniorage shares.

• Under the centralized IOU issuance model, the issuing company holds assets in a bank account and issues tokens that represent a claim on the underlying assets. To simplify, a stablecoin anchors a fiat money one by one. For example, Tether claims that for one USDT issued, they will deposit one US dollar into the bank account. The problem with this model is that the issuing company is still centralized. Issuing companies like Tether are private companies, which raise the concerns of pubic about their solvency and legitimacy.

• Collateral backed approach is to use other cryptocurrencies as collaterals to the stablecoin. Each time a stablecoin is issued, the issuing company will deposit a certain proportion of cryptocurrencies to the account. The whole process is generated by smart contract, so this approach has the advantage of being decentralized. However, even if the stablecoins are over-collateralized when they are issued, Black Swan events may still lead to insolvency.

• Seigniorage shares approach works like a central bank. They are “backed” by the expectations that they will remain stable. The price of the stablecoin is pegged as a fixed ratio to a certain fiat money. This model is very difficult or too early to operate. The model works under the circumstance that the market has a long-term demand for this stablecoin, which does not exist in the current market.

2) Stablecoin investment

Fluctuation and liquidity bring benefits. However, stablecoin has low volatility, and at present, only USDT has a decent trading volume. In addition, longing stablecoins does not make too much profits, but the cost of shorting is very low — you only need to pay the interest. Therefore, investors are more inclined to short stablecoins, bringing harm to the whole blockchain ecosystem.

3. Necessity and strategic significance of stablecoins

Some people believe that there is no necessity for stablecoins to exist. Although they do not have too much speculative opportunities as their counterparties, they still have many applications in the real world.

• Purchase of other cryptocurrencies. Many exchanges do not support fiat money purchase. Using stablecoins to purchase cryptocurrencies across different exchanges has relatively reduced the losses caused by price fluctuations, compared with purchasing through BTC or ETH.

• Settlement. Many funds and companies use cryptocurrencies to finance, bringing big challenges for auditing. In addition, if a company wants to go public, it can be audited based on stablecoins to meet compliance requirements.

• Bridge between cryptocurrencies and fiat money. Many countries are seeking the opportunities to issue government-endorsed digital currencies. Stablecoins link two worlds.

John Ryding, Economic Advisor to KoinEra and a former economist at Bear Stearns gave his opinion on Forbes about Stablecoin from the perspective of economists:

“There are three types of broad structures for stablecoins: fiat-collateralized, backed one-for-one with the underlying asset, say U.S. dollars; crypto-collateralized, backed with other cryptocurrencies; and non-collateralized. Each type of structure has its drawbacks. The fiat-collateralized structure requires a central custodian that holds the underlying currency and issues the token. In a sense, such a structure is like a digital bank deposit with the custodian issuing and buying back, however many tokens people wish to buy and redeem. The system lies in the complete trustworthiness of the custodian, who must subject themselves to audit. The question is how can such a structure make money?

Banks make money by lending out deposited money but we know that banks can be subject to runs. Just think back to the financial crisis. Ultimately bank deposits in the U.S. are guaranteed by the FDIC. Crypto-collateralized structures have to over-collateralize to absorb price swings and in many ways are similar to a tranched mortgage-backed security with a stablecoin tranche and an even more volatile residual component.

However, if a price drop in the crypocurrency that backs the stablecoin is too large, then the structure breaks down.

Finally, the uncollateralized structure is essentially purely fiat private money that is expected to trade at a stable value and the issuers have to buy and sell the stablecoin as its price falls or rises. A successful uncollateralized stablecoin issuer would profit from buying low and selling high to maintain the value but, like pegged currencies, these would be vulnerable to speculative attack and devaluation. To me, the ultimate stablecoin would be one that is backed by the central bank of the underlying currency to which the coin is tied.”

The issuers of stablecoins should pay more attention to supervision. On the one hand, it regulates and protects the rights of issuers and investors, and ensures the stability of the value of stablecoins. On the other hand, stablecoins have strategic significance for a country. Imagine an application that has a broad adoption in the world (like Facebook, Twitter), whose platform token is a stablecoin anchored to the currency of a certain country. The national currency’s status in the international arena will increase.

To conclude, although there are still many shortcomings in stablecoins, we should still keep optimistic. However, before they can be widely applied, stablecoins still have a long way to go.