Bitcoin crashed, and it took the other cryptocurrencies down with it—most of them, at least. Some currencies, however, were designed to keep their prices stable. The recent market fall was a test for these stablecoins – whether they delivered on their promise, or if they were unreliable.
A primer on stablecoins
Volatility is nothing new in the cryptospace – in fact, this attracted speculators who bet on their rise to gain hefty profits. But this renders the currencies unusable for daily transactions.
Stablecoins have been an attempt to confront this feature. Projects like Tether are pegged to the U.S. dollar, which makes every USDT worth exactly one dollar—nothing more, nothing less. The most important thing to note is that stablecoins are a financial vehicle, i.e. you cannot just “decide” that a coin should be traded for one dollar—what if people believe the coin is worthless? Then, no one would sell anything for that coin, and the coin issuers have to pay more coins to eventually persuade the sellers. The trick is to create a system that would never fall to this scenario. And so far, three methods have been invented: fiat-collateralized stablecoins, crypto-collateralized stablecoins and non-collateralized stablecoins.
Fiat-collateralized stablecoins have (as the name implies) fiat money backing their crypto. This means that for every digital coin, there is an equivalent fiat money in held in collateral in a central bank. This system works like an IOU, where every coin is perfectly tradable for an equivalent dollar.
Crypto-collateralized stablecoins intend to remove the dependency on fiat completely. This allows them to create a more decentralized solution by relying on crypto (such as ether or bitcoin) as collateral, but they are also more complex as the underlying asset is highly unstable. To confront this instability, these stablecoins are over-collateralized to absorb the shock of an eventual price fall. For instance, a user would need to deposit $200 ether to receive $100 in stablecoins—if ether falls by 25%, the coin still has enough backing to be traded for one dollar. Of course, these projects justify for this apparently $100 loss by paying interest or similar to the issuers, which in some cases allow the issuers to gain more than they have deposited.
Without going much into the details, crypto-collateralized stablecoins have a working model that is more decentralized and transparent than their fiat-counterparts, but also more complex.
The last category is non-collateralized stablecoins. In these projects, smart contracts are in charge to control the supply and demand scheme and ensure the price stays at one dollar. If the coin is trading too high, the system automatically creates new coins (historically called seignorage). If it is trading too low, the system buys up the coins in the market to reduce the circulating supply. If there are not enough coins to support this action, the system entitles you to future seignorage. In a way, the “collateral” in this system is the shares in the future growth of the system.
Non-collateralized stablecoins are complex and the most promising project in this area is Basis, which does not have an official launch date yet. This brings us to the next topic.
Are stablecoins real?
Stablecoins have been under fire for being doomed to fail. Tether, one of the first stablecoins pegged to the U.S. dollar fell down to $0.84 in mid-October when people started to doubt whether it is fully collateralized. Tether is a fiat-collateralized stablecoin.
Critics of this system claim that these coins have no reason to exist, as they are simply copies of perfectly liquid dollars that have been traded for cryptocurrencies with “questionable backing that is awkward to use,” so why not just use the dollar directly?
However, this could be said about just any cryptocurrency, not just stablecoins. Digital currencies have obvious advantages such as fast international payments, availability to anyone with an internet connection and the lack of need to go through a banking system.
Several big players are offering their own stablecoins, such as Circle’s USD Coin (USDC) which is backed by Goldman Sachs, or the Winklevoss twins with their Gemini (GUSD). They all indicate the potential for stablecoins. One of the recent players in this field is Elizabeth White, the CEO of The White Company.
Originally a trader of labmorghini and yachts, White quickly encountered the problem with crypto price volatility. For that reason, her company launched the White Standard stablecoin (WSD), the first to be built off the Stellar blockchain (which is 1500% faster than Ethereum, and 1/1000 the cost).
White did not repeat Tether’s mistake: “Tether has not had regular audits. In fact, they have had none from September 2017 until June 2018, and none since then. WSD is audited on a monthly basis.” She continues: “Tether’s holdings are in an unnamed bank, presumably offshore. WSD holdings are in U.S. based, FDIC insured institutions.”
The real performance
“In the last few days we’ve seen a drop of more than 30 percent for BTC and even greater for other cryptocurrencies,” said Ronny Boesing, CEO of Openledger. The stablecoins, on the other hand, did not crash. Shortly after bitcoin’s fall, USDC and TUSD were trading at one to three cents over the dollar. USDT was trading for an average of $0.97, with WSD in the same range. Openledger’s bitCNY, which is pegged to the Chinese yuan, also managed to keep its stability.
This all shows that so far, stablecoins have been able to keep their promises. Of course, they will probably not remain stable for all eternity, but the recent developments shows they have been able to absorb huge crashes after all.
This begs the question; what is preventing stablecoins from going mainstream? In the words of Boesing, whose OpenLedger DEX was the first decentralized trading platform on BitShares that started offering stablecoins: “a simple answer is lack of trust.” Many banks and exchanges are still reluctant to accept stablecoins, and a lot of them who accept them did that under public pressure. White’s intention is to make stablecoins more reachable for that public.
“Mainstream adoption of stablecoins will follow wider acceptance of stablecoin based payment methods in everyday life. That is why a two-sided network is the best approach to growing use. This means that stablecoins must find ways to allow their users to spend them through existing merchant networks, for example, a stablecoin based debit card like the upcoming White Card. On the other hand, merchant adoption of stablecoin payments will also help increase their use, with services like White Pay.”
Will demand for stablecoins increase? Can they remain stable if bitcoin keeps crashing? There are many forces at play. What’s certain is that digital currencies have a much higher chance for becoming a reliable trading asset if they step away from being speculation tools—and that’s where stablecoins excel.
Update: an earlier version of this article incorrectly referred to USDC as Goldman Sachs’ coin, while it is actually created by Circle and backed by Goldman