Cryptocurrencies have certainly offered multitude of benefits that fiat has been unable to do so. The rising values over time have made them an excellent investment vehicle. As a peer to peer network, they transaction system is always available, working during the night and on holidays. Their censorship resistance nature means everyone can access and use them.
However, on single issue with the tokenomics is its largest hurdle to adoption and general use: Price volatility.
Try Buying Groceries!
22nd May, 2010 was written in the annals of cryptocurrencies forever as the first time when the digital coins were used in a practical way. Laszlo Hanyecz traded in 10,000 BTC to buy two pizzas. With less than a cent per BTC, the purchase was not a bad one. Now fast forward to the current day. Hovering around $55,000, can you imagine paying $550 million for the food?
That’s where the essential problem lies. The price movements are just too much for cryptocurrencies like Bitcoin or others to be used for day to day purchases. Try buying groceries. By the time you purchase them and reach back home, you might the BTC rate changed so much that you realize you just spent way more than you should have using traditional currency. Unless and until cryptocurrencies solved their price fluctuation dilemma, they were doomed to be only used for wealth generation or trading.
The price of any asset or item is determined by the rule of supply and demand. If the supply shortens, the value rises. A lesser demand means the opposite. In short, in order to have a cryptocurrency that is stable, the supply and demand must be matched for it to have a consistent value.
This led to the creation of stablecoins, a class of cryptocurrencies which do not have fluctuating value and the supply/demand pressures are balanced to let it remain stable. This is achieved by having a mechanism that ensures each token or coin issued is backed. Rather than have their own price, the stablecoins are matched (or pegged) against an existing fiat. USDT, the largest stablecoin by market capitalization, is a good example. Tether, the company behind USDT, makes sure that the token is always equivalent to the US Dollar.
Combining the best of both worlds, stablecoins have opened up the opportunity for people to enjoy the same benefits of security, transfer easy, efficiency and economic factors of cryptocurrencies, minus the price volatility.
How These Coins Are Made Stable
There are four ways currently that the values of stablecoins are maintained. Each method has only one thing that they look towards: creating a value that does not change with changes in the supply and demand pressures.
The most common type of stablecoins, fiat collatorized coins are backed in a 1:1 ration by the fiat they are pegged to. That means for every coin or token minted, there is actually the same fiat in reserve by the issuer. If some party wants the stablecoin, they can approach the issuer and deposit fiat. The issuer will mint new coins in the same quantity. Returning the stablecoin results in the fiat being transferred back and the coins burnt to preserve the 1:1 ratio.
Examples of fiat based stablecoins are USD Tether (USDT,) TrueUSD (TUSD,) USD Coin (USDC,) and Facebook’s Diem.
Some stablecoins are not backed by fiat, but actual tangible assets and commodities, such as gold or other precious metals. There are some stablecoins that are even backed by oil, real estate and at times different assets combined in a single basket. Obviously, when I comes to these stablecoins, their value fluctuates in terms of fiat, but is stable against the backed asset.
One example of this type of stablecoins is Digix Gold Tokens (DGX.)
Very similar to the commodity stablecoins, these stablecoins have a cryptocurrency (or a collection of them) at their back. To counter the volatility of the crypto at the back, these coins are normally over collatorized. These tokens have a higher degree of decentralization as a smart contract functionality can handle the issuance and liquidation of the backed assets to maintain the value.
An example of this is Havven.
Counter intuitive in the start, this class of stablecoins (called Seigniorage-style coins) is not backed by any asset. Using what is known as seignorage shares, the supply of the tokens is regulated to manipulate and controlled to match the demand, creating an automated process of maintain the value against any asset or fiat the coin is supposed to represent.
One prominent example of this type is Basis.
Real World Applications
Stablecoins have the advantage of being used in any digital transaction. Since they don’t fluctuate in value, they are a good way to send and receive, and can be redeemed against their backed value without ease.
You can even pay for your morning coffee without the worrying of going home and stressing out over the changed value.
photo credit: Anastasia Gepp / Pixabay
Yea or Nay?
Stablecoins are said to be the answer to all cryptocurrency problems, mainly price volatility. The use if stablecoins will push cryptocurrency adoption to the next level, as stability mean steps closer to mass crypto adoption. However, this feature is despised by investors.
How so? Simply put, a $10-worth of stablecoins will still worth $10 after a year or two or more, virtually non-investable assets. Now compare that to the price of Bitcoin, which fluctuate a lot but attractive to speculators, long-term investors, and HODLers.
So, should you buy stablecoins? The answer would depend on your personal financial plan. If you want a decentralized version of fiat currency that gives you assurance and stability for your assets, stablecoins are for you. If you want to build wealth by making smart short-term and long-term investing decisions, then other types of cryptos may be your best options.
The choice is yours.