Stablecoins: how stable are they really?
The concept
In the “crypto world” stablecoins are popular as a concept and not so popular when it comes to the implementation. “Why” — you may ask.
Let me start with a definition, so we could all be on the same page; stablecoin is a cryptocurrency with a sufficient stability in price to be used as a store of value (in a short-term or a medium-term). Mostly it’s compared to gold — even though gold’s price has been changing over time — because of its attributes, it’s still perceived as a safe investment.
If we agree to the definition above, we get the following implications:
- Stablecoin is the opposite to fiat money in a following way: fiat money is regulated by governments and is perceived as money with intrinsic value;
- Stablecoin is a store of value but also (as a cryptocurrency) can be used as a transparent medium of exchange with minimum fee and trackable history on a publicly available blockchain.
So basically it’s “all-in-one”: not regulated by a third party (like government or other central institution) and at the same time stable(ish) in price; it’s a store of value but also an asset, a payment medium with attributes of gold.
Stablecoin with all these characteristics would be the perfect solution for popularizing cryptocurrency as a medium of exchange on daily basis.
Please think about all the requirements and implications for a moment (this is probably why it’s been so hard to implement the concept!).
The implementation
In the last few days, I did the research on projects related to stablecoins. As expected most stablecoins base their price on gold (in other words they are asset-pegged cryptocurrencies) or try to maintain the price against the value of the U.S. Dollar. Currently, there are only few functioning stablecoins; majority of the projects I’ve found are in progress or they provide too little information about their status. Let’s look at two (in my opinion) most interesting projects, that peg their coins to U.S. Dollars.
Contract Address:
0xdac17f958d2ee523a2206206994597c13d831ec7
The idea:
It’s quite simple. As we read on the official site “Every Tether is always backed 1-to-1, by traditional currency held in our reserves. So 1 USD₮ is always equivalent to 1 USD” [from the official site].
Total supply:
Currently the total supply of USDT is 1,650,000,000.
[source: coinmarketcap, January 25]
Blockchain:
Until recently Tether used Bitcoin blockchain (via the Omni Layer protocol) and now, in January, has switched to the Ethereum.
How the price stays “stable”?
Taken from their official site: “because they are anchored or ‘tethered’ to real-world currencies” and from their whitepaper “Tether’s Proof of Reserves configuration is novel because it simplifies the process of proving that the total number of tethers in circulation (liabilities) are always fully backed by an equal amount of fiat currency held in reserve (assets)”. So what they actually do is promising that you can exchange dollars for Tethers and number of Tethers will always be equal with the amount of dollars they have. They have regular audits regarding their accounts so that users can be sure, they always can exchange Tethers for dollars and the company is solvent.
Price:
Any Red flags?
On blogs and forums like Reddit I found many posts concerning Tether’s Terms of Service and inability to withdraw USD. Indeed in the ToS there was an entry stating the company have no obligation to redeem tethers at the face value (1 tether for 1 USD). As for now, after the last update of the ToS (January 03, 2018, source: https://tether.to/legal/) there is no such entry but also I haven’t found any directly committing to apply the rule 1 tether for 1 USD when redeeming tethers. That said, for now Tether is still very popular stablecoin and I’m curious how the project will develop.
Contract Address:
0x89d24a6b4ccb1b6faa2625fe562bdd9a23260359
The idea:
Maker is a decentralised autonomous organization governed by MKR token holders. They’ve developed a stable token called the Dai. Dai is created through “the Dai Stablecoin System, a decentralised platform that runs on the Ethereum blockchain” (from the official site). The crucial part of the system are Collateralized Debt Positions (CDPs) — smart contracts that enable to create Dai. They hold collateral assets: ETH which value corresponds to value of the Dai, that users generate. CDPs also create the debt, that is used to lock the deposited collateral assets. Once a user pays back the debt (with the Dai), his/her assets are unlocked and can be withdrawn.
As you can see, the mechanism here is more sophisticated comparing to tethers. Also here we have a smart contract that locks the money, which makes the system genuinely decentralised.
Total supply:
9,877,643.547174948661617472 DAI
[source: http://dai.makerdao.com/, January 25]
Blockchain:
It runs on Ethereum blockchain.
How the price stays the same?
The team behind Dai implemented several mechanisms which are to keep the price at the same level. They have the Target Price (“initially denominated in USD and starts at 1, translating to a 1:1 USD soft peg” [whitepaper]), the Target Rate Feedback Mechanism with Sensitivity Parameter and a process called Global Settlement. Unfortunately describing all of this would make a separate article, so I refer you to their whitepaper. Now let’s focus on the most important thing — what’s the price of Dai in the long term?
Price:
Any Red flags?
The only red flag I’ve found is the way of describing the project — the complexity of it is considerable. Therefore the team behind it should make an effort to explain it in the most understandable way, especially if they want to attract users. Moreover we cannot be sure if all the mechanisms embedded in the Dai coin work, until we test them on the market. But so far so good. The Maker DAO team will now focus on widespread adoption of the Dai and we can only wait to see how it will go.
The users
Ok, now let’s consider, who would benefit from a stablecoin?
First of all — everyone, who sees blockchain as a technology enabling to transfer money in a cheap, fast and transparent way in a trustless environment. Secondly, people who want to use cryptocurrency on the daily basis (for a number of reasons). To do this, the currency you operate on needs, to be stable in value (otherwise there is a big chance you, for example, overpay your purchase), so a stablecoin would be a natural choice.
People who wouldn’t be interested?
Those, who use the cryptocurrency exchange for quick earning gained by price fluctuations (and how many of blockchain users are in this group?).
Furthermore, when we think of mass adoption of cryptocurrencies, volatility of the price is one of the biggest obstacles. So maybe stablecoins are the answer to this matter? And if yes, where does it leave other cryptocurrencies? Where is their place on the market (if any)?
What’s next?
From where I stand there is still a long way to go before we see a fully-functioning and mass adopted stablecoin. And I’m not even sure if it’s possible to create this “all-in-one” coin; it is difficult to design something that is to be stable and at the same time available on the stock market, where the price of the coin depends solely on demand and supply. Tether and Maker DAO are examples of the projects, that try to implement “all-in-one” coin on the market. Therefore we all should watch them carefully.
→ In the next article I will describe stable coins backed by gold. Stay tuned and of course comments are more than welcome!
Post Scriptum
After I published this post, a few comments appeared on Facebook regarding Tether transparency and credit status. Also, there was a question, why I didn’t refer to these issues in the article. Mostly, because I wanted to focus on two different mechanisms that were used to build a stablecoin rather than companies behind them.
Secondly, I didn’t want to write about accusations when there is no court verdict. But the comments convinced me to present issues, that raise so many concerns and to leave them for your assessment.
Firstly the audit
- Since Tether (as a company) promises its clients to store their money in exchange for USDT, they had obligated to go through an audit and publish its results. Since they choose the centralised solution regarding money (in contrast to MakerDAO) this seemed like a reasonable compromise.
- The audit, that took place in September 2017, showed that the company actually had the declared sum of money, the audit itself raised concerns; it was incomplete and some information was hidden (you can find the whole document here ).
- Another audit, the results of which we should have by now, was interrupted because the Tether terminated the cooperation with the auditor, Friedman LLP.
The exchange
- Tether is strongly associated with Bitfinex, the exchange. They are two separate entities, but with the same people behind them.
- Yes, the exchange that lists USDT is indirectly its creator.
- Moreover, in December 2017 Bitfinex was subpoenaed by the Commodity Futures Trading Commission (a United States regulatory agency).
Last but not least in February I found this on Reddit
No comment is necessary, right?
About me: blockchain enthusiast. CIO at Trivial.co
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