Stable Coins: The necessary Evil (for now)
By Wes Carlson on ALTCOIN MAGAZINE
10 years after the release of the bitcoin whitepaper by Satoshi Nakamoto, it is safe to say that bitcoin has been a successful innovation so far. Like a swiss army knife, the technology is serving different purposes for users worldwide. However, the price volatility of bitcoin remains an issue for some. With the exception of traders, almost all other groups of users would prefer more stable price movements in order to lower certain risks.
Merchants, remote workers and individuals making cross-border transactions would all like to greatly reduce the risk of their funds losing value in the short term. Citizens of countries experiencing hyperinflation will also want less price volatility when they use Bitcoin to protect their wealth. Like all new asset classes, bitcoin is expected to become more stable in the future. In the meantime, the aversion to wild price swings has brought about a stable coin boom featuring a wide range of stable coins to offset the risks associated with the price volatility of bitcoin and other cryptocurrencies.
Stable Coins and Their Use Cases
Stable coins, also known as price-stable cryptocurrencies, are blockchain based- assets that are pegged to other stable assets. Most stable coins are tied to the US dollar or other major fiat currencies.
Being pegged to more stable assets makes price- stable cryptocurrencies equally stable and thus very useful in a cryptocurrency market characterized by extreme volatility.
The most obvious use case of stable coins is as protection against volatility. They allow users to transfer and store their funds on cryptocurrency exchanges while preserving value in fiat terms. For instance, a bitcoin trader who anticipates a drop in price can easily maintain the value of his assets by converting to a stable coin pegged to a fiat currency.
By virtue of being tied to stable fiat currencies, stable coins, unlike bitcoin, can be effectively used as units of account. Bitcoin is currently unsuitable for this use case due to its volatility. As a matter of fact, some cryptocurrency-related businesses have had to delay accepting bitcoin as payments due to issues revolving around bookkeeping and meeting regulatory obligations like the filing of tax returns.
Stable coins also come in handy when users wishing to trade on cryptocurrency exchanges try to enter the market with their fiat currencies. Due to regulations in different countries, it is currently not easy to exchange cash for cryptocurrency on crypto exchanges. Many cryptocurrency exchanges do not support fiat to crypto trades. Price-stable cryptocurrencies are often used as substitutes for fiat currencies. Entering and exiting the crypto market is therefore made easier using stable coins since they are worth the value of the fiat currency they are pegged to.
Additionally, stable coins allow traders to take advantage of different bitcoin prices on major exchanges. This is beneficial as the bitcoin price becomes more stable when more traders exploit arbitrage opportunities.
The Shortcomings of Stable Coins
Albeit being useful in the cryptocurrency space at the moment, one major criticism leveled against stable coins is that they are essentially digital “fiat” currencies without the advantages of decentralized and permissionless cryptocurrencies. For many dyed-in-the-wool bitcoin users like myself, stable coins or digital fiat currencies are not really true cryptocurrencies and defeat the purpose for which cryptocurrencies were created in the first place.
Another issue with stable coins is that they are often run by centralized entities with operations often shrouded in secrecy. This centralization poses risks for holders of such stable coins should they collapse for one reason or the other. For instance, investors can face huge loss of funds if the organizations behind some stable coins are identified and closed down by regulatory bodies for some reason. Funds could also be embezzled by leaders in such organizations.
There are also legitimate concerns about stable coins running fractional reserves. So far, none of the organizations behind stable coins have made their books public. It is therefore difficult to be certain that the total number of tokens in circulation are backed by real currency of equal amounts. The risks involved here for holders of such stable coins are obvious. There will be serious problems should any panic cause users to dump their tokens at the same time. For most early adopters of bitcoin, this is a serious concern since their opposition to fractional reserve banking in the traditional financial system is one of the factors that made bitcoin attractive.
In a nutshell, stable coins are serving a purpose in the cryptocurrency space but are generally viewed as a necessary evil because they are essentially what bitcoin was created to do away with. Centralized assets that are mostly pegged to traditional currencies and tend to practice fractional reserve banking are basically antithetical to bitcoin. However, the entire cryptocurrency space will have to make do until a better alternative is found or the cryptocurrency industry matures enough to survive without any links to traditional financial institutions.
There would also be no need for stable coins should Bitcoin become more stable in the future, this is because Bitcoin would then be suitable for use as a unit of account allowing Merchants to be able to quote prices in bitcoin.
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The purpose of ALTCOIN MAGAZINE is to educate the world on crypto and to bring it to the hands and the minds of the masses. This article was written and composed by Wes Carlson on ALTCOIN MAGAZINE.
