Stablecoin’s Past, Current and Future
By Krypital Blockchain Institute | Author: Jay, Edison & Rena
Since September 2018, “stablecoin” has been a topic that was constantly brought to the spotlight. After all those heated discussion, now it’s the time to revisit its journey of development. During the past three months, we saw the emergence of many new stablecoins, along with many comprehensive analysis (we will attach some selective ones at the end of this article). Given that, it might looks a little bit “redundant” for us writing another article, addressing the characteristics of each kind. In this article, we will explore vertically, starting from its history, to its current state, then we will lay out some possibilities for its future.
What is Stablecoin?
For blockchain enthusiasts, we are more than familiar with such concept. However, the general public might need a further explanation. Here, we would like to briefly introduce “what is stablecoin” in plain English.
For cryptocurrencies like Bitcoin, there’s high volatility associated with its price action as its hard to reach a balance with the existence of multi-parties, each trying to take control. The root cause can be explained as: due to their deflationary design, Bitcoin, along with other coins that have a fixed number of total issuance, cannot serve the purposes of the preserve of value and the medium of exchange at the same time. Even though stablecoins are one type of cryptocurrency, they are designed to preserve stable values. There are four major characteristics associated with stablecoins, we will attempt to provide you a better understanding by drawing the comparables to fiat payment system like Paypal, Wechat Pay and etc.
1. 24/7 Global Uninterruptible Visit
Not much to say in here. Similar to the current fiat system, which operates 24/7 uninterruptedly, you can transfer or exchange stablecoins whenever you want.
2. Expedited Transfer
Stablecoins should work as emails, not being restricted by distance, boarder, or the service providers. Backed by the blockchain technology, the expedited transfer can be realized. One highlight is international transfer. Especially for transferring large amount, Paypal or WeChat Pay takes several days to settle as lots of intermediaries need to be involved. Stablecoins, on the other hand, complete the entire transfer process within minutes. Thus, stablecoins have the potential to become the truly globalized, borderless currency.
At current stage, you can already send emails to other addresses with different service providers, sending to a Yahoo address through a Gmail, for example. However, in the fiat payment system, PayPal users are not able to send payment to WeChat Pay users directly, at least not yet. This is due to the fact that the current fiat payment applications lack the capability to directly transfer and settle on the open network. Bitcoin is the first case of the internet currency. As stablecoins are established upon the standards of open-sourced and decentralization, transactions can be enabled between stablecoins and any application with the same standards. If the stablecoin is issued with ERC-20, then transfers can happen between any digital wallets that are compatible with the ERC-20 Standard. Users are no longer restricted by the wallet they chose or the service providers of Dapps.
3. Micro and Macro Payment
This is a more interesting topic. Small or Micro-payment are actually not the best use case for stablecoins based on Ethereum. Nearly all attempts ends up in the increase of the gas fee, higher cost, lower transaction speed, and…epic failure. But on the other hand, stablecoins do provide a convenient way for macro payments. As the maximum amount can be sent through Paypal per transaction is $60k, 50k RMB for WeChat Pay, you can send millions or even tens of millions to any address through stablecoins.
Even though Macro transfer can be a great use case, compared to Bitcoin, there’s a problem with fairly centralized stablecoin as it is hard to know when the transaction is actually settled. As with Bitcoin, we know that the transfer is completed with the confirmation of multiple nodes. For centralized stablecoins, however, there’s a possibility for the contract being frozen or cancelled. We haven’t seen any of that for now, but that might happen if the local government confirms that the correlated addresses involve in darknet, money laundry, or drug dealing etc. We haven’t heard from any of the issuers regarding how the stablecoins shall be used, but centralization brings potential threats. Anonymity and privacy won’t be the focus. Whether stablecoins will be used in macro transferring is still a question mark.
4. Programmable Money
Programmable money brings traditional financial products new possibilities. With Ethereum, we saw the combination of cryptocurrency and smart contract gives birth to the truly programmable money. Based on which, we saw the ICO and primary market frenzy in 2017. The problems are also prominent. As most blockchain entrepreneurs are not familiar with the financial market, along with the volatility with ETH, they are suffering huge asset management risk due to insufficient risk management skills. Consequently, blockchain financial products will become more competitive if they are based on a cryptocurrency with greater stability.
Such volatility also presents a huge challenge for cryptocurrency entering into the debt market, as there’s huge credit risk associated with that.
For example, high volatility increases the correlation between market risk and credit risk. Xiaolai Li, an iconic figure in Chinese Blockchain Industry, was once blamed by the investors as the cryptocurrency price has increased more than tenfold during the lock-up period of his fund. Think about how much credit risk there will be if someone borrows a Bitcoin at $100 while needed to repay after its price soared to $20,000.
However, with stablecoins, people may able to issue programmable debt based on stablecoins, which are in turn based on Ethereum chain. In such case, interests and principals will be paid through the smart contracts, which will bring significant change to the $247 trillion global debt market.
What stablecoin means for different players?
One common question from people who’s new to the cryptocurrency is that: will Bitcoin or other cryptocurrency be accepted by normal vendors? As for now, stablecoin’s application in micropayment is limited by insufficient infrastructure and licensing issues, thus we haven’t seen the massive adoption. Circle is dedicated to solving those obstacles through USDC. We are expected to see a more integrated application in the future. Unlike Bitcoin, which involves volatile exchange rate issue, micro-payment shall be an ideal use case for stablecoins.
Now comes to the primary market investors. Stablecoins might serve as a better way of fundraising, compared with BTC and ETH. As analyzed above, projects raised by ETH or BTC face huge market risk. With the stable price, programmable features, stablecoins might become the next vehicle for fundraising in the primary market.
As for traders and arbitrageurs in the secondary market, stablecoins played an important role, for example, Tether is serving as a tool for the fast settlement. It also works as a necessary part for market makers and quant teams of triangular arbitrage strategies. Due to the volatility in the cryptomarket, traders load up stablecoins when perceiving the depreciation of value in other crypto assets. Stablecoins like Tether facilitate the entire trading process, make traders more comfortable in allocating assets on cryptocurrency without worrying about loss of value.
Regard to another heated topic, Security Token, will we see any change on the demand of stablecoins while more institutions start entering the game? The combination of smart contract and stablecoins may fundamentally change how investors trade and how companies raising capital. People may use stablecoins invest in the company’s Security Token instead of equities, while such security tokens will integrate smart contracts, paying investors stablecoins through pre-programmed terms and schedules. As a result, it is able to reduce the market risk for both parties.
The category of stablecoins and their current status
In the above, we did not subdivide the types of stablecoins but only explained in a vague concept. In this section, we will enter a few more stablecoins tracks. Haaseb Qureshi, GP of MetaStable Capital, in his article 《Stablecoins: designing a price-stable cryptocurrency》, proposed a classification of stable coins, which we have used for reference in this paper as the basis for the following analysis.
- The concept is very easy to understand, that is, depositing a certain amount of dollars into the bank and then issuing the same amount of stablecoins through the blockchain;
- Regardless of the fluctuations in the cryptocurrency world, the Fiat-collateralized stablecoin is 100% stable. The stablecoin can be redeemed as US dollars, and the ratio of stablecoin to fiat currency (US dollar) is always 1:1;
- Centralization, depending on the solvency and honesty of the issuer, if it’s not transparent, it is easy to cause market panic (recently happened to Tether), and many new Fiat-collateralized stablecoins have increased transparency;
- Regulatory pressure is high, will subject to the constraints of the local government, need to count on the third-party trustable institutions to increase credibility.
- The existing Fiat-collateralized tokens account for almost 95% of the stablecoins market;
- With the first-mover advantage, although Tether has some negative news, it still has the largest transaction volume and highest market value, and Tether also gets the most support from exchanges.
- Circle USD is the newest to market but has the fastest rising in ranking. PAX is growing pretty fast as well. They all emphasize more transparent, regulatory-compliant, which should not to be underestimated;
- Among the top 100 market cap coins, there are now four Fiat-collateralized stable coins, and it is expected that this number will continue to increase as the market develops, which may impact the entire crypto currency market. If the Fiat-collateralized stablecoins can meet everyone’s needs, then the existence of other digital currencies will be weakened;
- The stablecoin DGX, which is collateralized by gold, is not used by many people. Most of the exchanges supported are decentralized exchanges, and the trading volume is weak.
- There are slight differences in the redemption terms, such as True USD, which requires a minimum redemption amount of $10,000. You need to do KYC/AML verification while you redeem. For USDT redemption, it is clear that 10 base points or $20 will be charged, other coins didn’t have that. Also, there may have some fees on the bank side. The redemption process for Digix Gold Token is relatively more complex.
- Now that the new world of crypto currency has been opened, why should we still use the old way to put fiat-currency into a bank as collateral? So this category of stablecoins is trying to get out of the fiat-currency and use pure cryptocurrency as collateral;
- The concept is relatively complicated, and it takes time to understand. It will not be explained in this article. If you want to know more about how Crypto-collateralized stablecoin works, you can refer to this article 《Maker for Dummies: A Plain English Explanation of the Dai Stablecoin》;
- It is transparent, decentralized and in line with the spirit of cryptocurrency;
- The sceptic says that this type of stablecoins is more susceptible to price instability, and that they will be destroyed spontaneously by the sharp fall of prices, which may cause imbalance between supply and demand and break the stability.
1) The market acceptance of Crypto-collateralized stable coins need to be further verified. Currently, only MakerDAO (DAI) has a market capitalization ranking among top 100;
2) In the exchanges that listed MakerDAO (DAI), we did not see the large ones, so it is still a question mark whether it could be accepted by major exchanges. The price volatility of DAI is slightly greater than Fiat-collateralized stablecoin, but it still could stick around $1 US dollar. If there is market volatility, DAI itself will fluctuate too. The range of fluctuation is still acceptable, the time for adjusting is also very fast, Dai’s total market value is also growing, can refer to the following figure:
3) Although BitUSD was launched by Dan Larimer in September 2014, it did not break through its restrictions. It can only be traded in BitShares. In this way, the use case will be very difficult to expand, and the future growth space may be limited.
- This classification is very difficult to define, and the proposed solution is also the most complex and abstract. The white paper can be very confusing, and we doubt whether a Doctor in Economics can understand it.
- There is no need to propose a collateral concept because the US dollar was originally linked to gold, but after the collapse of “Bretton Woods“, there was no collateral relationship between the US dollar and gold. This is the origin of the Growth-Collateralized Stablecoin, which using the future growth of the entire system as a collateral and using algorithms to adjust supply and demand to achieve stability;
- Regardless of its complex design, the above two types of stablecoins will serve as the foundation for this type of stablecoin design for a long time.
- As we can see from the above table, this type of stablecoin is still in the concept stage, and none has actually been tested by the market. So it’s hard to say whether it works or not, we need to stay tuned;
- It can be seen that many VC funds have invested in this area. Unlike the above stablecoins, the Growth-Collateralized stablecoins do provide more incentive for investors because the value will increase with the growth of the whole ecosystem.
What the future will look like?
In sum, we believe that stablecoins will serve as an irreplaceable part of crypto industry’s future.
The past several years laid out a clear pathway for the development of stablecoins. Initially, the demand for a medium of exchange with more stable price gives birth to fiat-collateralized stablecoins. However, the concerns over centralization, lack of transparency, and strict regulation is a deviation from where Bitcoin get started. The awareness of such issue fuels the development of DAI, a crypto-collateralized stablecoin. However, its design is rather complicated. Many institutions believed that they are able to create a better version, with better transparency, regulation-compliant, and better liquidity. As a result, we saw many new stablecoins came to the market this September and October with improved features, including GUSD, PAX, USDC and etc. In the near future, we are seeing other fiat currencies like Euros/ Yen will serve as the collateral of stablecoins. Other regulated issuers may also become the issuer of stablecoins. For each fiat-collateralized stablecoin, there might by several institutional issuers.
People may wonder whether there will be a RMB-collateralized stablecoin in the future. We are cautiously optimistic for this problem. Cautious comes from the distinctiveness of the Chinese Capital Market.
If the stablecoins collateralized by RMB collateral are on chain , which will be equal to allowing the free global circulation of RMB, based on Mundell Impossible trinity, Chinese government will lose the control of the exchange rate. It is not acceptable. However, the RMB has long been hoped it could be accepted oversea as a settlement tool. There is no doubt that put the RMB on chain is the best solution. The US dollar-collateralized stablecoin approved by the SEC has once again made the dollar more international accepted. More use case for US Dollar has been added in this way, and we know Chinese RMB wants to do the same.
Chinese mobile payment system has been well developed and widely used, and the No-cash society has almost been realized. For many young ones, money has already become a digital thing. Moreover, the central bank of China has done a lot of research on blockchain technology. The changes of regulation in Hainan and Hong Kong are very positive signs, which may lead to a small trial use case. These are the reasons why we are optimistic about RMB-collateralized stablecoin.
Unfortunately, we could not draw the launch time for growth-collateralized stablecoins on the above timeline. We really don’t know when will the third type, decentralized, controlled by the algorithm growth stable currency can launch and tested by the market.
It’s hard to predict the future yet the crypto world is full of surprises. We will look forward to it.
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