Stablecoins are attracting attention. Why? The value of most cryptocurrencies, especially Bitcoin, fluctuates – sometimes wildly. Virtual currencies aim to facilitate ever more secure transactions, but their values seem increasingly to involve speculation. In all this blockchain technology plays a major role – providing the underpinnings and infrastructure.
Stablecoins are more fixed than ‘normal’ cryptocurrencies – because their values are pegged to other assets like fiat currencies or commodities. As a result, promoters of stablecoins enjoy many cryptocurrency benefits (transparency, security, privacy, etc.) without the volatility that comes with other digital coins. In a (downloadable) report entitled What are stablecoins?, CB Insights examines:
- what are stablecoins?
- why use stable coins?
- types of stablecoins
- real world applications
- looking ahead.
What are stablecoins?
Stablecoins seek to replicate the advantages of traditional, stable currencies – via some form of digital money. This means that, in general, a stablecoin is a cryptocurrency collateralised by the value of a specified underlying asset.
What that underlying asset may be can vary between stablecoins. For example, some stablecoins have a 1:1 peg to specific fiat (US dollar, Euro, Yen, Yuan, etc.) These are tradable on exchanges. Other stablecoins reflect other kinds of assets (see below). Thus stablecoins seek to:
- leverage the benefits of cryptocurrencies — such as transparency, security, immutability, digital wallets, fast transactions, low fees and privacy
- avoid losing the guarantees of trust, stability and usability associated with fiat currency.
The primary promoted attraction is users need not worry about sending a speculative asset – sat Bitcoin or Ether – which could suddenly increase or decrease in value. Yet, stablecoins are also showing promise in other emerging applications. For instance, both industries and individuals needing to make international payments quickly and securely, even migrant workers wanting to transmit their earnings back to families – are beginning to see stablecoins as a potential means for cheaper, more efficient ways to make cross-border payments.
The report identifies four broad types of stablecoin (although the suspicion must be that some financial genius will try to cross-combine two or more of these):
- fiat collateralised
- commodity collateralised
- crypto collateralised
Fiat-backed stablecoins are backed at a 1:1 ratio, meaning 1 stablecoin is equal to 1 unit of currency (like a US$). So for each stablecoin that exists, there is (at least in theory) a real fiat currency held in a bank account. In effect when someone wants to redeem cash with their digital currency, the entity that manages the stablecoin will take out the amount of fiat from its reserve to transfer to the owner’s bank account. Examples include Tether (USDT) and USD Coin (USDC).
There are two downsides. As long as the economy of the currency a stablecoin stays stable, then the value of a fiat collateralised stablecoin should not fluctuate much. This should mean that if, say, an entire cryptocurrency economy collapsed (in effect driving the price of (say) Bitcoin to zero), it would not affect a fiat-backed stablecoin. The second disadvantage is knowing whether a fiat-backed stablecoin really has fiat equivalent ‘in the bank’ and, related, whether more digital currency is issued than exists in fiat reality.
Commodity-collateralised stablecoins are backed by other assets, such as:
- gold (and various other precious metals)
- real estate.
Holders of commodity-backed stablecoins hold a tangible asset that has tangible value — which most cryptocurrencies lack. They even have the potential to appreciate over time. This offers an increased incentive for some to hold and use these.
Cryptocollateralised stablecoins are backed by cryptocurrencies. One asserted advantage is this means these stablecoins possess greater decentralisation than fiat-backed equivalents – since everything happens on a blockchain. (The question has to be asked – can a stablecoin based on cryptocurrency(ies) be stable?).
Non-collateralised stablecoins have no backing. Can they be stable?
Applications and limitations
The report discusses some potential applications. These include:
- as a day-to-day currency, for ordinary commerce (this is as a medium of exchange)
- smart contract-based payments, including P2P
- affordable remittances say for migrants
- protection from local currency speculation and/or volatility (think Venezuela or Zimbabwe)
- improved cryptocurrency exchanges.
In terms of limitations, probably the greatest is trust – trust that an entity is backing its stablecoins with real assets (clearly this does not apply to non-collateralised stablecoins. As the report says: “To solve this trust problem, stablecoins should provide regular audits from third parties to ensure transparency. This will help ensure that they are trustworthy and can help keep their reputation high.”
Enterprise Times: what does this mean
Ignoring for a moment the BIS view of cryptocurrencies, the problem with this report – at least to Enterprise Times (ET) – is it fails to make a credible case for stablecoins. Yes, there are plenty of examples and possibilities. But none has (yet) the ring of ‘practical usability’ – even if the economic justifications (particularly to bypass the inefficiencies of today’s financial infrastructure) are reasonable.
As the report says: “Each form of stablecoin comes with its own unique set of benefits and drawbacks, and none of them are perfect. Yet the value and stability they could (ET’s italics) provide to businesses and individuals globally — by enabling universal access to established national currencies, streamlining payments and remittances, and supporting emerging financial applications — could be disruptive. It’s still too early to determine success, and the many emerging stablecoins out there will have to experiment with these new concepts to see what works and what doesn’t. Widespread adoption of digital currencies more broadly will depend on whether or not crypto can appeal to everyday users and use cases.”
Whether one believes in stablecoins or not, there appears to be a case for them. But only if trust can be sustained and they do not become so complex as to be incomprehensible.