By Thomas Coughlin, Chief Executive Officer of Allocated Bullion Exchange and Kinesis.
Stablecoins are currently the fastest growing sector of the cryptocurrency market, worth $186 billion; these constitute cryptocurrencies whose values are pegged to real life commodities like gold or the US dollar. This is opposed to traditional cryptocurrencies—such as Bitcoin or Ethereum—whose markets are very volatile and can fluctuate by 10-20 percent in the space of a few hours, causing massive uncertainty among investors.
Governments across the globe, from Australia to Sweden, are realizing stablecoins’s potential and developing their own, in addition to official blockchain funds which develop GPB and Japanese Yen-pegged coins.
Types of Stablecoins
There are numerous stablecoins on the market, which fall into three main categories: fully collateralized, partially collateralized, and uncollateralized. Uncollateralized stablecoins are designed to increase and decrease supply in the same way a bank buys and sells its debt in order to stabilize purchasing power.
The stablecoin Basis refers to this as having an algorithmic central bank and uses ‘crypto-bonds’ which have attracted criticism for being too similar to the flaws of the traditional banking system. Broadly recognized as the most reliable type of stablecoins, however, are those which are fully collateralized with steady units of value, such as gold or US dollars.
The biggest stablecoin currently on the market is Tether, which is backed by the US dollar. They claim to have actual reserves of dollars to back each unit of Tether, although critics point out there is inconclusive proof.
Nevertheless, despite the strength of the US dollar, it is still subject to the same volatile financial markets as other fiat currencies. Political and economic downturn devalues currencies, with measures taken to reduce government deficits, such as quantitative easing, which results in inflation.
In contrast, the price of gold has remained stable for hundreds of years—proving itself a reliable quantitative measure of value. For centuries, currencies around the world were made of or backed by gold. In fact, until 1971, the US still operated under the gold standard—a monetary system whereby the value of a country’s currency is directly linked to a fixed price of gold.
Today, central banks and government policy control monetary systems. This creates periods of economic growth— which are always followed by crashes. A central system of floating rates has had devastating, unpredictable effects on savings. In contrast, gold has a vast, stable global stockpile, growing on average only 2 percent each year from mining activities.
Era of Digital Currencies
It’s becoming more apparent that we are entering an era of digital currencies. Sweden’s central bank, Sveriges Riksbank, is in the final stages of developing the e-krona. This stablecoin is pegged to the Krona and will act as a digital equivalent of the country’s fiat currency. So far, 87 percent of global central banks are now investigating the possibility of launching their own currency-backed stablecoins, with Australia to launch theirs in 2019. Additionally, the multi-million blockchain fund Xiong’An, which is 30 percent funded by the Chinese government, is planning to launch a Japanese Yen-backed stablecoin.
Worldwide, stablecoins in their fundraising ICO phases have attracted millions of dollars’ worth of investment from reputable multi-national corporations. This proves that stablecoins are a respected alternative to traditional banking, valued for their reliable software that leaves no room for error.
Regulations and Gresham’s Law
However, a vital element required for stablecoins to flourish is better market regulations, as many are concerned about the security and legitimacy of cryptocurrencies. Government and international bodies across the globe are already fighting this, including multi-national accountancy firms and tech start-ups, such as Elliptic.
A crucial issue also plaguing cryptocurrencies is Gresham’s law of money, which states that “bad money drives out good.” This means that if there are two or more active currencies, the most valuable currency is always overtaken as it is traded less due to investment motives. Volatile cryptocurrencies face this problem of hoarding behavior.
Stablecoins in possession of a yield system, however, promote the use of a currency whilst equally distributing back wealth. There should also be efficient measures in place to recover one’s collateralized assets, providing simple processes in which to verify or retrieve these assets. Transparency will be intrinsic to stablecoins’ future success.
Impact of Stablecoins
Stablecoins have the potential to transform the cryptocurrency scene and move blockchain technology into the mainstream.
They will encourage the use of crypto payment applications, and their steady value means they can be used daily for shopping—currently an impossibility for volatile cryptocurrencies. Industry experts widely believe that non-volatile cryptocurrencies can provide a layer of infrastructure that could immeasurably expand cryptocurrencies’ percent user base. They offer a valuable link between digital coins and fiatcurrencies—free from the perils of inflation—as well as providing less risk for prospective investors.
There are bound to be initial issues with innovative technologies, and stablecoins will need concrete guarantees of their stability, greater governance, and transparency before they’re projected into the mainstream. Nonetheless, they have the potential to completely transform our financial institutions in the near future.