Will The Real Stablecoin Please Standup?

real stable coin

(first published June 15 2020)

The novelty that greeted the invention of cryptocurrency is wearing off and this is great for the space. As the hype tapers off cryptocurrency is slowly evolving from being just a passing trend to living up to its potential as a viable alternative to fiat currency. It has been a long and arduous journey thus far with global adoption still out of reach. A major barrier to cryptocurrency’s progress is its famed price volatility. It’s difficult to forget the great bitcoin crash of 2018 that saw bitcoin price plummeting a record 80%. The crypto space is comparably more stable today but it’s not out of these turbulent waters just yet. Stability is important for any currency that wants to achieve à store of value status. For cryptocurrency to shake off its notoriety as a high-risk investment, it had to tackle its underlying volatility issues head-on. The concept of stablecoin has been presented as a worthy solution.

At its core, a stablecoin is a cryptocurrency that maintains a stable price because it derives its value from another asset which it’s pegged to. Stablecoins have many obvious practical applications. From being useful as a hedging tool against hyperinflation and serving as alternative currencies for everyday transactions and recurring payments to facilitating cross-border payments and ensuring financial inclusion for all, stablecoins have found widespread appeal in and out of the cryptocurrency and blockchain industry. This fact is underscored by the meteoric growth of the stable coin which has seen its market cap rising from $3.6 million in 2014 to $10.4 billion in 2020. The last few years have seen the proliferation of stablecoin projects and several pegging systems have since been explored which can be summarized into 4 categories: fiat collateralized; crypto collateralized; non-collateralized; asset collateralized. Each has its pros and cons; ultimately, its usability depends on having a stable price equivalent to the asset it’s pegged to and this has been a challenge for many stablecoins.

Fiat collateralized stablecoins use fiat currencies like USD as collateral or peg to ensure the price of the stablecoin reflects the currency that it’s backed by. This is executed by having the fiat reserves that backs the coin correspond with the supply of the stablecoin. Several challenges have been observed with this system. Its centralized structure means it has a single point of failure which is counterintuitive to what cryptocurrencies stand for. Fiat backed stablecoins also require trusting the issuing party and the custodian of the fiat. This greater need for oversight and regulations continues to be a major sticking point impacting the efficiency of this type of stablecoins with none yet to fully reflect the price of the fiat is backed by. Past and present prominent fiat collateralized stablecoins include Tether, TrueUSD, StableUSD, PAX, USD Coin, Libra, BitUSD, Gemini Dollar, AAA Reserve Currency.

Crypto-collateralized stablecoins as the name suggests refer to stablecoins that are backed by other cryptocurrencies. It is appealing for some since it centers on traditional cryptocurrency features such as decentralization and smart contracts which is used to handle the issuance of new coins. But cryptocurrencies including top-performing ones are notorious for their price volatility. This contradicts what stablecoins represent and backing them with such volatile assets will result in price volatility in the long run. Due to this challenge, projects using this pegging system have had to over-collateralize their stablecoins. Some crypto-collateralized projects/stablecoins include: MakerDAO/DAI, Money on chain, Atomic Loans, Havven

Non-collateralized stablecoins are sometimes called algorithmic stablecoins (also Seigniorage-styled stablecoins). Tokens of this nature are not backed by assets; instead price is maintained by algorithms that control the circulation of the coin in a manner reminiscent of traditional central banks. Coins are distributed or restricted based on the demand of the coin. Creating the perfect algorithm to do this has continued to prove elusive. Projects working to achieve this include: Anchor, Basis, Fragments, Terra, Carbon, Kowala,

Commodity collateralized stablecoins are the final example of stablecoins. This form of stablecoins is growing in popularity because of its inherent potential to solve Cryptos volatility issues. These stablecoins preserve their price by being pegged against real-world assets that have intrinsic value. Due to their nature, these real world assets are more stable than digital assets. Examples of real assets that have been tokenized on a blockchain include Gold, Silver, Diamond, etc. Projects include: Aurus, Digix, Tether Gold, Pert Mint Gold, Pax Gold. Despite being the best form of stablecoin at the moment, issues such as counterparty risk and centralization have posed some challenges.

Future of stablecoins

Early signs indicate a bright future for stablecoins. Despite having a market share of $3 billion at the moment, fiat collateralized stablecoins’ early lead in the space will be short-lived. The reason is not farfetched. A stablecoin is only as good as its backing. Fiat monetary system faces an impending crash due to its increasing volatility as users continue to see a decline in their purchasing power. Any stablecoin pegged on this failing system cannot last. Commodity-backed stablecoin appears to be the long term solution due to the aforementioned issues. As this space evolves, stablecoin cryptocurrencies are projected to be more than just a hedging tool, finally taking its place as the long-awaited replacement of the fiat currencies.

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