One concern that crypto skeptics might share is that cryptocurrencies like Bitcoin are subject to significant price fluctuations. This, they might say, makes cryptocurrency impractical as a medium of exchange.
Although the dollar and other widely used currencies also vary in value, consumers may be less likely to experience inflation or deflation of the dollar (or the Euro, or other fiat currency) as immediately as they change in the value of their Bitcoin. Prices may rise over time, ultimately reducing the purchasing power of your banknotes, but the changes are generally more subtle than those affecting cryptocurrency.
The crypto sector’s answer to these volatility concerns: stablecoins.
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What Are Stablecoins?
Investopedia defines fixedcoins as “a new class of cryptocurrencies that seek to offer price stability and are backed by a reserve asset”. Different types of “reserve assets” support different fixedcoins, including:
- Other cryptocurrencies, with the most popular coins like Bitcoin and Ethereum serving as a value tether for lesser-known stablecoins
- Fiat currency, with the dollar being one example
- Tangible assets such as gold, silver, or other commodities that have real value
The asset that supports a particular stablecoin can affect how the issuer of the stablecoin sets the price of a ticket. For example, supporting a stable with Bitcoin obviously brings a level of risk. If the price of Bitcoin falls significantly, then the pricing of fixedcoins too high in relation to Bitcoin could leave the stablecoin issuer unable to exchange consumer coins for equal value in Bitcoin.
Therefore, fixedcoins tied to relatively volatile assets like other cryptocurrencies must connect value conservatively, ensuring that even if the value of Bitcoin drops significantly, they have a buffer to be able to repay ‘ all the circulars in circulation.
There are also unique considerations when stablcoin support is a commodity such as oil. Not only accounted for in the fixed price of such a currency is the value of having the support of real assets, but also the cost of compliance by the coin issuer: legal fees, maintenance fees, and all the real costs incurred skill of keeping the operation above the table. These fees can exceed those required for dollar-backed or Euro-backed stablcoin – simply more moving parts.
There is another class of stablecoin with no asset support, referred to as Seigniorage style or algorithmic stablecoin.
Instead of being tied to a commodity, these coins are even more stable in price and value. Their supply and price are embedded in code, and are generally governed by smart contracts to provide true stability.
What are the Benefits of Stablecoins?
The main benefit of fixed interest is dead gifts: they are fixed. Or, at least, they are considered stable compared to other cryptocurrency classes.
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Stablecoins have two main benefits:
- They have less volatility than non-fixedcoin tokens
- By reducing volatility, cryptocurrency becomes a more viable exchange method
To illustrate the value of fixedcoins, consider the following scenario.
Say I would like to buy you a pizza or motorcycle. I offer to pay you the price of the pie or bike in Bitcoin or Ether, but you have some understandable concerns:
Sure, the value of the Bitcoin you are offering is equal to the value of the product now, but will it be in five minutes? What about five days?
It could be bigger, it could be significantly less. Traders generally may not be willing to gamble that they will be left taking a loss on their product, especially when other customers are willing to pay for the pizza or motorcycle with a more stable asset as cash.
Furthermore, to reduce the risk of value fluctuation after being paid with traditional cryptocurrency, a seller would have to rush to his digital wallet and convert the coin into dollars as soon as possible. This costs them time, effort and fees. Even then, they may still lose out of the transaction even before considering fees.
With stablecoins, and especially those tied to an unchanged pool of assets, this price volatility becomes much less of a concern. In turn, bidders see stablecoins as an easier to use exchange medium.
What is the Current State of Stablecoin Use?
There are two different categories of stablecoin, and each can be assessed individually to measure their popularity and usefulness. They are:
- Central stockings, also known as collateralized Bitcoins
- Devolved Stacks
Centralized stabilizers are ones backed by real-value assets, and their volatility can vary from one coin to another. For example, a fixedcoin tied to an oil price may be more volatile than one tied to a fixed pool of untouched gold. Generally, these coins include custodians to manage supply and discuss administrative aspects of the coin ecosystem, rather than…
Devolved institutions. This second category of fixedcoins relies on algorithms, which is why they are sometimes called algorithmic stablecoins, to maintain price consistency. These algorithms that regulate coins incentivize consumers to buy or sell based on deliberate economic drivers, with the ultimate goal of keeping the coin’s value within a pre-defined price range. That is, to keep the coin stable.
Generally speaking, the combined popularity of fixedcoins is huge (in crypto terms) and growing. According to Bitcoin.com, the market capitalization of all fixedcoins exceeded $ 20 billion at the beginning of October.
Stablecoins may have more promise as a model for wider adoption than other types of cryptocurrencies. With major governments including China embracing digital currency and financial nails like MasterCard jumping on board, the relative stability and economic viability of fixedcoins can only shine a brighter light on the merits of this class of crypto.
How Do Regulators View Stablecoins?
Ask a question about regulation and (insert subject related to cryptocurrency here), and you are liable for a variation of the same answers:
- We cannot be certain
- Historical precedent indicates potential trouble
- It does not look good
- We can hope for the best
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While ridicule and madness might be a fair projection for the more progressive, mature-fraudulent crypto projects, there is reason to hope that regulators do not drop a heavy hand on fixedcoins.
Yes, generally there needs to be some regulation in the crypto space. Where there is a way to exploit others for a huge cash reward, a system of checks and balances is required.
And yes, reports from powerful bodies like the G-20 state that they are wary of fixedcoins in particular. This can legitimately be considered a harbinger for future regulation.
But there are also signs to indicate that the mainstream may be more willing to accept stablecoins than they have been to other classes of crypto. The The Office of the Currency Manager (OCC) now formally allows certain national banks to deal with funds generated from the issuance of fixedcoins. The decision is limited to fixedcoins backed by the US dollar (read details here), but from a regulatory perspective it is a step in the right direction.
It is hoped that regulators will see stablecoins as an essential part of the emerging digital economy, rather than a threat to central financial systems to be “squeezed”.
Regulators decide whether this prospect is largely becoming a reality, and it will be worth paying attention to the specific decisions they announce as the influence of fixedcoins becomes ever greater.