Stablecoins entered the crypto world not long after Vitalik Buterin presented Ethereum; coins which are backed by gold, the US dollar, and even sand. They associated themselves with whatever commodity you can imagine and were minted one after another. Some became a universal stepping stone between the traditional and crypto economies, such as Tether, while others sank into oblivion. One thing remains obvious however — stable coins have formed an integral part of the crypto economy.
What is a stablecoin?
A stablecoin is basically a cryptocurrency designed to minimize price volatility relative to other assets or groups of assets, such as gold or the euro. In some way, stablecoins are tokenized commodities; stablecoin owners do not own the assets backing them, but they are exposed to the price movements of the associated asset. Let’s consider the case of a stablecoin backed by gold. If the price of gold relative to US dollar increases, the price of the stablecoin raises also.
Stablecoins are largely divided into several groups dependent on the type of asset backing them:
- commodity-backed (e.g. gold, silver etc.)
- fiat-backed (e.g. US dollar, EURO)
- cryptocurrency-backed (e.g. Bitcoin)
Commodity-backed stablecoins are usually considered to be an investment instrument. Similar to buying gold within bank accounts, cryptocurrency traders can buy gold on exchanges. Sometimes commodity-backed stablecoins are used as a payment unit because they are less likely to inflate than fiat-backed assets.
Fiat-backed stablecoins are widely used as payment instruments and generally form a means of stabilizing profit and losses by cryptocurrency traders. As everyone still operates in the fiat currency economy, it’s much more convenient to make transfers and assess trading efficiency in US dollars, for example. The most popular and criticized (due to non transparent backing) stablecoin is Tether (USDT), where 1 USDT equals 1 US dollar. You can have a closer look at this coin and its pros and cons in the post: What is Tether (USDT) and How to buy it?
Cryptocurrency-backed stablecoins are not that well-known, even by crypto enthusiasts, but are more familiar to blockchain developers. Some are used to make payments and transactions faster (a BTC transfer can take up to 30 minutes for example), but far more often such stable coins are used for decentralized exchanges.
Here’s a brief description of how a typical decentralized exchange (DEx) works:
- The client brings their funds (eg. Bitcoin) to the so-called gate. The gate stores the client’s Bitcoin and issues the same amount of tokens (let’s call them DexBTC for this example) that can be traded within the DEx’s blockchain. Basically, these tokens are collateralized by the real Bitcoins kept at the gates.
- The client sends an order to sell their DexBTC and receive, say, DexETH in exchange. The order, matching process, and resulting trades are all stored on the blockchain — that’s the really important part of this concept.
- After receiving the DexETH, the client may then convert it to real ETH (Ether) using the same or another gate.
How do stablecoins work?
To ensure the stable coins reflect the price of its underlying asset, the issuer needs to back each token with the one standard unit of the asset. In the case of gold, Digix, for example, buys physical gold on exchanges and undergoes a regular audit to prove the backing for the Digix Gold Token. In practice however, many stablecoin issuers have a conspicuously non-transparent asset backing structure which is often subject to much criticism e.g. the Tether case.
Many consider stable coins to be beneficial for the cryptocurrency market, considering that they provide familiar and safe objects for investing. Others believe these assets prevent the development of a “true” crypto economy, with BTC, not the US dollar at the core, inhibiting true decentralization. This is because stablecoins are not truly decentralized, they usually have an issuer, something like a big bank. Will you bet that big banks never collapse?
Governments tokenizing national currencies
Law drafts and suppositions aimed at tokenizing national currencies are not new; Sweden’s Riksbank has considered the possible issue of the ‘e-krona; as an alternative to cash, and so too has the leading political administration in Germany.
"It's not only the low cost of operations, but above all the Swedish government's eagerness to embrace new technologies which presents an opportunity."
Head of Data Centers by Sweden
National cryptocurrency law drafts have been issued in several other countries, including China, Russia and Venezuela. The Venezuelan Petro could actually become the first actual national cryptocurrency, and the case is pretty interesting.
The story of Petro began with Venezuela’s socialist government led by President Nicolás Maduro launched his own national cryptocurrency backed by oil. But international exchanges wouldn’t accept the Petro. This is not surprising, as the currency was created primarily to avoid sanctions imposed by the US and other countries which have hammered the economy. Initially, the Petro was described as a stablecoin, pegged to the value of the nation’s oil reserves, but later it was suggested that upon listing on exchanges, the Petro price would be swayed by market forces.
In August, 2018 Maduro’s government devalued their national fiat currency, the bolívar, by 95% and pegged it to the Petro. So now the bolivar is pegged to the Petro (supposedly) which is also pegged to oil. A very curious case indeed.
Facebook’s Libra — A Stablecoin To be Used Globally
The recently announced Libra coin by Facebook is also considered a stablecoin. Unlike most however, it is pegged to a group of “low-volatility assets, including bank deposits and government securities” in multiple currencies.
“That means that there’s just one Libra, no matter where you live. Levine is great here, too, so I am going to paraphrase him again: if Libra does catch on, it’s likely to displace currencies like the dollar. That’s because if you spend mostly Libra, perhaps because you buy most things online, you’ll only convert your Libras into dollars for when you need to spend IRL money, and the dollar will begin to seem annoying to you since it keeps moving up and down relative to the Libra”.
Many believe that Facebook, with its billion plus users, will be able to easily compete against fiat currencies with the Libra, which could potentially lead to mass cryptocurrency adoption. Nevertheless, the Libra is cannot be defined a completely decentralized and thus can not be described as a 100% cryptocurrency like Bitcoin.
To sum up, stablecoins compose a large part of crypto economy, whether people like it or not, and global cryptocurrency adoption is likely to go down this path. Some time ago, the wave of commodity backed tokenization swept through the world, leading to the emergence of really odd products, such as sand and forest backed tokens which soon proved their inviability. Now, as the market matures, we’re likely to see more serious and promising initiatives from corporations and governments, each introducing stablecoins into their existing infrastructure.