The latest innovation in the fast-paced ecosystem of cryptocurrencies is “stablecoins”. These are cryptocurrencies pegged to real-world assets such as the dollar, euro or gold. It’s a global currency, but is not tied to a central bank and has low volatility. This allows for practical uses such as paying for everyday purchases.
How Do Stablecoins Work?
There are two types of stablecoins – reserves-backed and algorithmic.
Reserve-backed stablecoins function same way paper money does when linked to the gold standard. As cash is backed by gold reserves in a central bank, reserve-backed stablecoins are backed one-for-one by reserves of the currencies they’re pegged to.
The second type of stablecoin is not backed by any reserves but instead controlled by an algorithm.
Importance of Stablecoins
Price volatility bedevils coins such as Ethereum and Bitcoin. Swings of 5% or even 10% in a day can happen anytime. This makes using most cryptocurrencies for daily transactions inconvenient. Stablecoins are an attempt to control the benefits of crypto by transferring value digitally and combine them with the trust and stability of mainstream currencies.
Uses of Stablecoins
The most common use of stablecoins is as a liquidity tool for cryptocurrency exchanges. Most banks have shut out many exchanges from mainstream banking because they’re wary of dealing with anything related to crypto for compliance reasons. As a result, many exchanges are unable to accept dollar or euro deposits. Stablecoins offer a solution for clients who want to buy with dollars and trade out of crypto into dollars during high volatility.
Stablecoins proponents believe the technology can allow the creation of more complex financial products on crypto including smart contract dividend payments, insurance, and loans.
Who’s developing Stablecoins?
New startups and existing crypto business such as Circle and Gemini crypto exchange are developing stablecoins. Venture capitalists also have their eye on the space. According to a Blockchain report, stablecoin projects teams have raised $335 million to date. Silicon Valley fund Andreessen Horowitz recently made a significant investment of $15 million into stablecoin project MakerDAO.
The Biggest Stablecoins
Tether is currently the most popular stablecoin. Exchanges use it to offer dollar-like liquidity. It’s also the second most actively traded cryptocurrency (60% of BTC daily trading volume). In early 2018, it entered the top 10 crypto asset rankings by market value. Despite its popularity, Tether has been plagued by criticism of its auditing standards, claims of manipulation, and corporate obscurity.
Maker is a decentralised autonomous organisation. It’s pegged against the USD though backed by ETH. Dai is their stable coin and one is worth $1. It maintains stability via an autonomous system of smart contracts.
Hevven’s structure provides stability by building a system that backs itself with two coins. The first coin, Nomins, is the stable coin and is used for everyday transactions. Havvens are the tokens sitting in reserve.
Basecoin pegs their price to $1 USD, though their approach uses consensus to contract and expand the supply of the coin. When coins trade for less than $1, the coins are contracted by allowing coin holders to buy bonds. Supply decreases and price increases after the coins used to buy bonds are destroyed. To expand the supply, do the opposite.
Facebook Inc is also working to make a cryptocurrency that will allow users to transfer money on its WhatsApp messaging app. According to insiders, it’s first focusing on the remittance market in India, which has 480 million internet users, second only to China.
For cryptocurrencies to go mainstream, the ecosystem needs price stability. This will give users the confidence to make daily transactions. Full adoption of stable coins will lessen the worry of having to time your purchase with the volatility of coins such as Bitcoin and Ethereum. The ambitious projects working on stable coins will usher users into a world where you can use cryptocurrencies to buy lunch, coffee, or pay for groceries!