Imagine you have a car with amazing features. It can either perform like a Ford Mustang GT on one day and within a short period of time, becomes a Ford Pinto on the other. It might be fanciful to say that you own a car like that. However, you would not risk taking that car on a drive out to the countryside.
This precisely is the problem with cryptocurrencies. It is the volatility of these cryptocurrencies that render them unusable for practical transactions. On a day, you could buy a Lamborghini with one bitcoin and on the very next day, it might not even be worth an iPhone. Just imagine the fate of Lamborghini if you want to buy its car on a day and if the very next day, the price that you paid for it is not even worth a hundredth of its original value.
It is true that this volatility plays a major role in making cryptocurrencies an ideal entity for trading. However, it is the same property that deters users from considering cryptocurrency as a mainstream instrument of payments and transactions.
What if the convenience of the cryptocurrency was coupled with a solution to make it considerably less volatile? The answer lies in collateralization. If cryptocurrency is collateralized by the value of an underlying asset which could be a fiat currency or some commodity like gold, it is bound to be less volatile and stable. We will look at the different kinds of stable coins divided by the backing that they have in a later section.
These kinds of stabilized cryptocurrencies are aptly known as Stablecoins.
Stablecoins are expected to solve a lot of practical problems when it comes to financial transactions. To understand the importance of Stablecoins, let us look at a few Stablecoins in existence.
JPM Coin by JP Morgan
This is a coin backed by the value of the dollar. It was introduced by JP Morgan in February 2019 and it runs on the permissioned blockchain called Quorum. Quorum is the permissioned variant of Ethereum. It is the second dollar-backed cryptocurrency from a major bank. The first one was the Signet by the Signature Bank.
Facebook Libra
Facebook started working on blockchain technology in 2017 and introduced its permissioned digital cryptocurrency in May 2019. Facebook has planned its full launch of Libra in 2020. There have been questions on the status of decentralization as the coin emphasizes on relying on the trust in the Libra Association.
A lot more of these Stablecoins are available in the market but let us look at the details of these coins later. We reserve the best for the last because some of them are even backed by the Governments of countries!
The Need for Stablecoins
The Automated Clearing House (ACH), the electronic fund transfer system that serves the United States takes around 24 hours to process a domestic payment. It is to be understood and remembered that this fund transfer system process payments in the world’s largest economy. Across the Atlantic ocean, in Europe the SEPA (Single Euro Payments Area), the same domestic payments might take anywhere between a few hours and over a day to settle the payments.
There might be faster payment options that were provided by companies like Paypal. However, they come at an additional cost which might not be available for small businesses.
When it comes to electronic payment, it has to be agreed that Asia leads in this regard. The BahtNet and the Chinese Interbank Payment Clearing Systems can process payments almost instantaneously.
So far, we have been talking a lot about payments within borders. However, the need for payment processing is not always domestic. There are companies that do business across the globe. There are a lot of migrant workers who might want to send money to their families in another part of the world. Also, the growth of global tourism would mean that a global network of instant currency exchange is required.
This is where the importance and relevance of Stablecoins come in. Stablecoins are expected to play an important role in factoring the global economy into local economic development.
Different kinds of Stablecoins
As we have seen, what distinguishes a stablecoin from all other types of cryptocurrencies is the collateralization. Stable coins are backed by some asset or the other. It can be pegged to a cryptocurrency or fiat money or to exchange-traded commodities like precious metals.
Asset-backed cryptocurrencies also give the advantage of decentralization. The assets are not under the control of a centralized body but rather in a network of decentralized commodity holders.
It is to be noted that the value of the assets fluctuates outside the cryptocurrency ecosystem. They are susceptible to volatility but the intensity of this volatility is only because of the fluctuations of the actual asset itself.
Commodity-backed Stablecoins have their values pegged to commodities that are precious metals like gold and silver. They are very less likely to be inflated than fiat-backed Stablecoins. This stability can be attributed to the fact that you cannot mine gold or silver just like that. People who owned these coins can redeem their Stablecoins at the conversion rate to acquire real assets. The Digix Gold Token (DGX) is a good example of a commodity-backed stablecoin.
Fiat-backed Stablecoins have their value based on some backing currency which is held by a third party financial entity. the financial entity, in most cases, is highly regulated. The trust in the custodian of the backing asset forms the very basis for the stability of this coin. the cost of maintaining the stability of this stable coin is equivalent to the cost of maintaining the backing reserve and the cost that is involved in establishing legal compliance. Fiat-backed cryptocurrencies are the most common form of Stablecoins. Some of the most common fiat-backed cryptocurrencies are TrueUSD (TUSD), Tether (USDT), and Paxos Standard (PAX).
Cryptocurrency-backed Stablecoins might seem like an oxymoron. While it was only because of the volatility of cryptocurrencies that Stablecoins were introduced, these Stablecoins derive their stability by using cryptocurrencies as collaterals. The collateralization is done on the blockchain itself. The price-stability is achieved through the introduction of supplementary incentives and instruments. This moves the dependence on stability outside the collateral itself. This kind of cryptocurrency works by allowing users to take a loan against a smart contract by locking up collateral. Technically, it is more of a loan that is issued against a specific volume of cryptocurrencies. If the collateral decreases too close to the value of withdrawal, smart contracts can liquidate the user. Havven and DAI are classic examples of these kinds of Stablecoins.
There is another kind of stablecoin called the Seigniorage-style coin that is not backed by any asset. It works similar to a central bank’s approach to printing and destroying currency notes. They are far less popular and the value is controlled by supply and demand. The algorithms stabilize the price. One example of this kind of coin is Basis.
The ‘Practical’ Stablecoins
It is quite possible that you have heard about the X series of flights tested by the United States Air Force. They might have been great the status of advanced technology but they would not have been useful to actually do what they were intended to point in the same way there are a lot of stable coins that we have been looking at until now but given below are the list of Stablecoins that might adequately or even more than adequately be used for transactions.
THEBEX – It is a stable coin developed by the payment service Everex, and it derives its value from the Thai Baht. it was even approved recently by the bank of Thailand. It works to accelerate and simplify the remittances that happen between Thailand and Myanmar. It can also be used as an instrument of payment settlements in South East Asian countries like Laos, Vietnam, Myanmar, and Singapore in addition to Thailand.
Tether (USDD) – As the name implies, it is a stable coin backed by the United States dollar. For many cryptocurrency enthusiasts, this is the first name that comes to their minds when we talk about Stablecoins. It has been dominating this space ever since its creation in 2015. It has recently made its switch from the OMNI protocol to the ERC20 protocol which is considered to be far more advanced. It is quite possible that there will be increased adoption of Tether, given that most of the commodities around the world are traded in United States dollars. it would not be a surprise if Tether gains its ground in Asia which is considered to be a great market for the United States.
Coins regulated by the US – there are a lot of coins similar to Tether like the USDC, TUSD, and PAX. They might not work well with the Asian markets but are sure to be a big hit in the Central and South American markets. they will open the gates or rather, cross the walls, to become an instrument of easier payment from these countries.
The Criticisms
There have been cases where Stablecoins have been accused of being unable to provide audits for the results. Tether was one of the victims and its unverifiable creation was attributed to the Bitcoin price rise in 2017. However, it is observed that it is only the volatility of the Bitcoin that has brought even this negative publicity to the stablecoin. There have also been instances where stablecoin projects have been abandoned because of regulatory requirements. NuBits was one of the Stablecoins that failed to maintain its pegged value. Basis received a funding of $100 million in venture capital, but it shut down citing concerns over US regulatory requirements.
Conclusion
Any new technology will go through its ups and downs in the four finding a fine line on which it can operate successfully. This fine line will ensure that the advantages of the technology are not compromised and at the same time will also ensure that the traditional values of the market are maintained.
Stablecoin can be considered one such confluence of technology and traditional values. It will not be long before Stablecoins become a mainstream mode of transactions especially when it comes to cross-border markets.