5th October 2018
Stablecoins: The Solution to the Volatility Problem
Cryptocurrencies like Bitcoin have come along with promising features and abilities. Although Bitcoin has shaken the world as a disruptive and game-changing technology, its volatility is a huge problem. One of the initial and most important intentions of Bitcoin was to be used as an everyday payment system. Simply put, it was intended to be a “peer to peer electronic cash system,” as titled in the Bitcoin white paper.
So far, Bitcoin and other major cryptocurrencies have not been able to perform this initial important use case well. While there was initially some adoption from merchants, the adoption has been slow and due to technical issues, many merchants have dropped their support for Bitcoin and others. One reason merchants are unwilling to adopt crypto payments is the volatile price. In the current climate, one Bitcoin can be worth anywhere between $5800-$7000.
To make up for crypto’s shortcomings, there is another class of cryptocurrencies that aim to solve the volatility issue that is ultimately holding Bitcoin and others back from being the everyday payment system they were designed for. This new breed of cryptocurrencies are appropriately titled “stablecoins.” Stablecoins bring the promise of solid price support that can be used as either a store of value, or an everyday means of exchange. It is for this reason that many are heralding stablecoins as having a far greater potential than Bitcoin.
A stablecoin is a cryptocurrency that has stable price characteristics. Most stablecoins are pegged to the U.S. Dollar, while the upcoming Kinesis project will create coins that are backed by gold and silver bullion.
If you want to know more about cryptocurrencies and their history, check out this cryptocurrency guide.
The ultimate goal of stablecoins is to be an incredibly stable digital form of fiat-free cash, with the potential to solve the problem of cryptocurrency volatility.
This provides traders and investors a safe haven during a market crash that can impact fiat currencies significantly. It also shields them from issues related to fiat currencies.
Lack of support
Due to strict regulations and banks becoming wary of cryptocurrencies, there are only a few exchanges that support fiat currencies. This makes it difficult to complete transactions using fiat-based cash.
Slow transaction times
It takes several days to send fiat to and from a bank account. Transfer between the ACH Bank and Coinbase wallet, for example, can take as many as 7 to 10 calendar days.
As previously mentioned, regulations are now stricter when it comes to crypto-related transactions. This makes it difficult to purchase or pay for goods using fiat currency.
When cryptocurrencies exploded in the mainstream market, their value increased exponentially, resulting in a flood of investment capital to Bitcoin and other cryptocurrencies. After the crypto mania phase, it wasn’t long before more than 50% of the price of bitcoin decreased, along with the drop in media interest and its trading volume.
This kind of cryptocurrency volatility can cause a large exodus of investors. It will also affect other cryptocurrencies that want to gain mass adoption status. It’s hard to argue for the adoption of a currency in business if merchants can’t rely on the daily value and fees associated with the currency. At the height of crypto mania in 2017, Bitcoin users were spending as much as 100$ or more for a single Bitcoin transaction due to the back log of transactions on the network. Transactions often took days to complete. This is unacceptable for business adoption.
Stablecoins want to address this volatility by providing investors with a stable cryptocurrency. For it to work however, it has to satisfy the requirements of sound money. That is, it must be a store of value (SoV), a medium of exchange (MoE), a unit of account (UoA), and fungible. It must be easily moved and divisible as well.
Store of value (SoV)
This refers to a form of wealth which current value is maintained even to the future without any depreciation. Examples of solid stores of value are gold, silver, and other precious metals.
Medium of exchange (MoE)
For stablecoins to be a medium of exchange, it has to facilitate the sale of goods without using barter in the equation.
Unit of account (UoA)
A cryptocurrency must provide a unit of measurement that will allow its value to be defined and compared. For example, the cost of a car could be 10,000 units of a stablecoin. All cryptocurrencies can be used as a unit of account.
Stablecoins matter because they are relatively stable in value, unlike Bitcoin and Ethereum. This is why it is often considered as a hedge against volatility, insulating you from the market volatility that is associated with cryptocurrencies like Bitcoin or Ethereum.
If you trade 1 BTC for a stable coin, for example, its value will be the same even if the price of Bitcoin drops. You can also have stable coins converted back to BTC anytime.
This makes stable coins ideal to use to invest in options, derivatives, and prediction markets. It is also a better currency of choice if you place a bet with a long and extended timeframe.
How stablecoins work will depend on the type, whether its reserve-backed, algorithmic, or backed by other cryptocurrencies.
The first type functions like paper money. Instead of being backed by gold reserves in a central bank, it is backed by one-for-one currency reserves that they are pegged to which in this case, are U.S. Dollars.
A good example of this type of stablecoin is Tether (USDT). Even without any public proof, the 2.5 billion USDT coins that are in circulation are backed by dollars.
Algorithmic stablecoins on the other hand, are controlled by an algorithm. There is software that controls the supply of the stable token, increasing and decreasing it to maintain its peg.
Cryptocurrency-backed stablecoins, as the name suggests, use cryptocurrency as collateral instead of fiat money. Done on a blockchain, it removes third parties from the equation.
The problem with this type of stablecoin, however, is that the cryptocurrency introduces a source of volatility that makes a stablecoin less stable than it is supposed to. As a solution, more collateral than a 1:1 basis is introduced into the transaction. For example, for a guaranteed $100 worth of a stablecoin, a larger amount of $150 worth of ether (Ethereum) must be deposited first.
Stablecoins are commonly used as a liquidity tool for cryptocurrency exchanges. Many exchanges are wary of anything related to cryptocurrency because of its volatility, but stablecoins offer a solution to the problem.
Stablecoins are a new class of cryptocurrency that offer steady valuations and price stability. It is designed to retain its purchasing power with little to no impact from inflation.
In order to maintain steady valuations, stablecoins are tied to price stable assets like gold or the U.S. dollar. Different methods are used to achieve price stability for different stablecoins.
For now, there are three broad categories of stablecoins. But there are other stablecoin proposals at work and may be introduced sometime in the future.
This type of stable coin uses a particular amount of a standard fiat currency as collateral. To issue crypto-coins, for example, U.S. dollars, gold, or oil can be used as collateral.
A central entity is responsible for the collateral and will issue a token representing the money they hold. The ratio of the number of crypto-coins issued is also 1:1 against the fiat currency it is pegged to. This is why fiat collateralized is the most straightforward method of stablecoin creation and operation.
Apart from a central entity or custodian that holds the collateral–fiat currency or commodity, this type of stablecoins require operational processes to ensure that valuations of collateral are maintained up to the mark. Processes include frequent audits and valuations.
A popular example of a stablecoin using this type of architecture is Tether. On paper, it has a market cap of roughly $2.3 billion and with a daily volume that exceeds $1 billion. The token is hailed as the most stable cryptocurrency but is plagued with controversies from the lack of professional and publicly available audits.
There is also TrueUSD, a flagship offering from TrustToken. It is a U.S. dollar-pegged stablecoin. It has a transparency mechanism designed to avoid issues that affected Tether. It currently has a public sale on CoinList.
StableUSD, on the other hand, is another type of fiat collateralized stablecoin from Stably. It is backed by USD with every token fully backed and redeemable 1-to-1. It also offers support to multiple blockchains, including Stellar and Ethereum.
Similar to TrueUSD, it aims to be verifiably transparent. Third party audits and real-time electronic bank data serve as verification of the cash reserves backing of each stableUSD.
Fiat collateralized stablecoins however, have their share of problems. For this type of stablecoin to be successful, users have to trust the central entity that holds the money or collateral.
In the case of Tether, trust is not exactly working out well. This is especially true with allegations about insolvency and accusations that this particular stablecoin is being used to drive up price of Bitcoin on exchanges.
Crypto-collateralized stablecoins depend on the cryptocurrency value that they use as collateral to maintain a stable target price against certain assets. Unlike fiat-collateralized stablecoins, which are simple but centralized, crypto-collateralized stablecoins are used in a much more decentralized approach, as they are backed by cryptocurrency reserves.
In essence, these types of stablecoins work quite similar to their fiat counterparts. The only difference is, the collateral is not considered as assets in the real-world, but rather another cryptocurrency. They are extremely volatile. Thus, they are often over-collateralized (there is a huge rate of capital involved) to account for the price volatility of the underlying crypto collateral.
Also, in the crypto-collateralized stablecoins system, a bulk of cryptocurrencies account for the price stability achieved by a particular stablecoin. While using these stablecoins is good for everyday situations, holding long term could be risky. There is still no account that this method has already been rigorously tested in real markets.
One crypto-collateralized stablecoin is MakerDAO. Despite its increasing popularity, the implementation of such cryptocurrency has been perceived by users as complex and difficult to understand. Under the system, the user needs to deposit crypto assets into a smart contract, then receives a certain number of stablecoins. As previously implied regarding the use of these stablecoins, the cumulative price of the stablecoins he receives is lesser than the value of the crypto assets he deposited.
One more major issue with using crypto-collateralized stablecoins is that if your crypto assets go through significant value depreciation, the loans you have taken out will be automatically liquidated.
Unlike crypto-collateralized stablecoins, non-collateralized stablecoins are cryptocurrencies with stable prices and are not backed by collateral. Their implementation involves a system or an algorithm that contracts and expands the coin supply depending on the coin value. Basically, the non-collateralized stablecoin approach is based on the Quantity Theory of Money, which implies that “there is a direct relationship between the quantity of money in an economy and the level of prices of goods and services sold.” This means that the coin supply will depend directly on the prices of the stablecoins. For example, if a coin’s value is above $1.00, the supply would increase. On the other hand, if the value drops to less than $1.00, the supply would decrease. These activities create upward and downward pressure on the coins’ value, as needed.
To understand more about this, let us take a look at some popular examples of non-collateralized stablecoins.
Basecoin – Launched in October 2017, this stablecoin is backed by some of the biggest names in the industry, such as Metastable Capital and Andreessen Horowitz. A re-brand of Basecoin, called Basis, applies a 3-token system using Basecoin, Base Bonds, and Base Shares to implement a system that is similar to an algorithmic central bank. When the supply decreases, bonds are offered at a subsidized rate to pay for the principal and interest in the future. When the demand increases, the supply would also increase. Thus, new coins will be created.
Base Shares – Simply known as “shares” in the cryptocurrency market, these tokens come on a fixed supply at the blockchain. These coins are not pegged to anything, with values stemming from their corresponding dividend policies. When demand for such coins goes up and more coins are created, shareholders would also receive newly-created coins as long as all outstanding bonds are redeemed.
Carbon – This stablecoin is built on the Hashgraph platform and is compatible with smart contracts, making it highly feasible for use in financial applications. Specifically, it is considered to be used for the decentralized applications (dApps) landscape and for the Ethereum-based games, where a smart contract compatible stablecoin would be a good catalyst.
Saga – Saga is a non-anonymous stable cryptocurrency that is backed by a solid set of advisors, such as JP Morgan Chase chairman Jacob A. Frenkel, (chairman of), Cornell professor and IC3 director Emin Gün Sirer, and PHP developer Zeev Suraski. This stablecoin is quite unique from its counterparts, as it is backed by reserves and uses a variable fractional reserve, which is essentially a reserve of conventional currencies. Its supply depends on the size of the Saga economy.
Reserve – Founded by Nevin Freeman, this stablecoin originated as an investment round from Coinbase. How it will be implemented is yet to be seen.
Overall, stablecoins are likely to evolve over the years. The market around these coins would become more and more competitive, with gradually rising interest in cryptocurrency.
What is the most stable cryptocurrency?
A better question would be what is the best stable cryptocurrency? Because there are several options. None of them are perfect, however.
Stablecoins are gaining popularity over other types of digital currencies because of protection from volatility. With links to real-world assets like U.S. dollars, precious metals like gold and silver, and oil, a stablecoin gives traders mental peace, an option for easily liquidated currencies, and eases up concerns on instability.
Like most things, stablecoins have their problems as well. In fact, even the best stablecoins have certain disadvantages.
According to its website, Tether USDT is “100% backed by USD” with a conversion rate of $1 per 1 Tether. This offers some stability in a crypto space filled with other volatile currencies. But there are reasons for concerns.
Although it uses blockchain technology, the fact that it is run by humans, who are potentially capable of making mistakes, make Tether less reliable. Many believe that Tether is being issued by the same people that run the Bitfinex exchange, another leading exchange that accepts USDT as collateral for trading. This led to the assumption that the 1:1 ratio is not absolute and there might be some fractional reserve lending that is happening behind the scenes.
Many fear that Tether Limited does not hold enough U.S. dollars to back the stablecoins that are in circulation. In January alone, there were 850 million new digital tokens that Tether released. While this looks good in the sense that there is more capital flowing into crypto, critics say that the cryptocurrency market might be manipulated. This is because the increasing number of tokens released coincided with the record high prices of crypto.
Poses a systemic risk
With the trading volume of Tether regularly exceeding its market cap, the investment research firm Weiss Ratings thinks of it as a threat to the ecosystem. This is because Tether is one of the main sources of liquidity.
As the Weiss report goes, “What happens if Tether does turn out to be shaky? … What if this large source of liquidity suddenly evaporates?”
This is one of the best ERC20 stablecoins on the crypto market as it is pegged with the U.S. Dollars. This can be likened to the Tether USDT, except that it is fully fiat-collateralized, verified transparently by fiat-collateralized like TrustToken, and is legally protected. The people who manage the token are previous employees of Google, UC Berkeley, and PwC.
But TrueUSD might not be as stable as it’s supposed to be. In fact, its price showed some volatility, following the announcement that the token will be listed on Binance. Its price had a sudden rise at an unprecedented 40%. It eventually subsided but it did reach $1.39 per token.
This led to fears that the price return will dip below $1.
But just like in March when TUSD was listed on Bittrex, traders were advised not to pay more than $1.05 per token to avoid losing money.
Are the bots really to blame for the price bump?
According to Rafael Cosman, co-founder and CTO of TrustToken, bots that are always listening for announcements of new listings tend to “buy any coin as soon as it is listed on a new exchange” to make more profit. But he is confident that anyone who knows that the token is redeemable for $1.00 will not pay for more as they stand to lose money.
People are also anticipating on how the token will fare following an audit of its financial situation. Because the token is backed by U.S. dollars, many are wondering if it has enough to back the stablecoins in circulation. Tether for instance, has failed to present a proper audit test.
At this stage, stablecoins can be considered highly experimental. So, expect some highs and lows even from the best stablecoins on the market. Investors however, don’t let these concerns stop them from trading, especially in the short-term. The fact that both Tether and TrueUSD are secured against the U.S. dollars and not subject to the level of speculations that other cryptocurrencies have brings the attention of investors.
Just stay aware of what’s going on with these tokens on the market before you trade. Keep an eye out for the sudden bumps and drops and don’t pay more than what you’re supposed to for each token.
This stablecoin is currently the only one on the Stellar Blockchain, which is known mostly for its fast transaction times. Launched in August 2018 by The White Company and Fintech with the aim of creating a seamless foreign currency monetary system for users.
During the official press release, CEO of The White Company, Elizabeth White, said, “Our goal is to unleash crypto’s real-world potential, and this partnership with Interstellar is the first of many steps in not just bringing the White Standard stablecoins to the masses, while increasing the ease for consumers to purchase Stellar lumens (XLM) with USD, GPB and the Euro.”
White standard offers three variants of coins, tied to the US Dollars, UK Pounds or Euros. Once all the kinks are worked out, it is touted as allowing seamless deposits, withdrawals, and transfers in all three currencies.
The White Company partners with Interstellar, an integrated decentralized exchange (DEX) platform and cryptocurrency wallet powered by the Stellar protocol. Currently, they offer users access to five major cryptocurrencies: Bitcoin, Stellar Lumens, Litecoin, Ripple, and Ethereum. This partnership will integrate the White Standard stablecoins so that Interstellar will be able to allow users to instantly withdraw, deposit, or transfer through the White Standard stablecoins. It may seem like WS stablecoins are quite similar to Tether. The only difference is that the latter does not offer current audited information.
However, the White Standard is backed by the USD for the same reason the USD was backed by gold. Because it’s currently the worldwide medium of exchange it becomes easily traceable into any good or service.
While there are concerns about inflationary pressures on USD, they have not yet been realized and are likely far off for now.
What makes the Kinesis system an evolutionary step toward a better monetary system is that it acts as a store of value and a medium of exchange both at the same time.
The Kinesis currencies will soon be launched in November 2018 and will have two currency systems: KAU and KAG. These will be minted into existence and will represent precious metals, which are the bases for the cryptocurrency 1:1. This means that 1g gold is equivalent to 1 KAU and 10g silver is to 1 KAG. These will be stored and insured in third-party vaults that will be audited twice every year.
Amazingly, the Kinesis system is designed to actually work. It’s not just any metal in a vault.
The workings of the Kinesis system include:
Kinesis Currency Exchange (KCX) – where the coins will be produced.
Kinesis Blockchain Network (KBN) – where the coins will be utilized.
Kinesis Blockchain Exchange (KBE) – where coins are traded.
Kinesis Digital Bank (KDB) – where transactions are held.
Kinesis Commercial Centre (KCC) – where various companies are able to offer goods and services.
Different users will have the option to choose any form of exchange they want for gold, silver, and other major currencies, like the euro, dollar, pounds, franc, and yen. All of these will be integrated with the rest of the world using conventional channels. These include debit and credit cards on the MasterCard and Visa networks, as well as ATM networks, telegraphic transfers, Western Union, PayPal, MoneyGram, and more.
What makes Kinesis unique is that it offers price stability, which isn’t available in other stablecoins. This currency system does this by basing its currencies to physical precious metals, like gold, which has a strong store of value for the longest time. Thanks to the minds behind it, they have gone through the list of everything that could possibly go wrong with every coin and have provided solutions to each one of them.
Kinesis also has a rewarding multi-faceted system that is unlike any other. It is also hedge-free because it offers assurance on price stability, as well as trading to a wider variety of assets. This is made possible by having strong partnerships with the world’s leading electronic institutional exchange for physical precious metals, like gold and silver, ABX (Allocated Bullion Exchange), as well as Deutsche Borse Group and European Commodity Clearing.
Unlike Tether, wherein its tokens are backed by the US dollar yet are at high risk of fractional bank reserves, Kinesis transactions are conducted through bullion exchange networks. Aside from that, its users are rewarded through its velocity-based system, wherein rewards are based on frequency and rate at which they are carried out.
In essence, Kinesis can be considered a trustworthy stabilizing force that drives up velocity further in the cryptocurrency world. In a way, it will offer a more suitable replacement for the highly controversial Tether token. Furthermore, there is a better incentive to trade capital.
The Kinesis system has a multi-faceted yield system that is unlike any other. It provides incentives to users’ participation by attaching it to different types of yield. This means that anyone who participates in the Kinesis system receives money for every transaction, as well as for the overall rate of money-changing hands.
In other words, the system provides a great reward for using such currencies. This means that this stablecoin addresses an important issue that fiat monetary systems have: the need to inflate prices and devalue the currency to stimulate activity in the monetary system.
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