What is a Stable Coin? Finding Stability in Volatile Cryptocurrencies

What is a Stable Coin

Cryptocurrencies are notoriously volatile. With Bitcoin jumping from literally having zero value to an all-time high of $19,000 at the end of 2017, dropping down to $3,200 early 2019 and today, early August 2019 sitting at $11,700 USD. While this is great for speculative investors, it makes using the cryptocurrency in everyday life quite stressful and cumbersome.

Moreover, since Bitcoin’s creation, there have literally been thousands of other cryptocurrencies, all seemingly equally volatile. We know that cryptocurrency is a great technology that will truly revolutionize finance, but how do we adopt cryptocurrency as a stable way to transact?

Enter the stable coin.

“What is a Stable Coin” Contents:

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What is a Stable Coin?

Stable coins are exactly what they sound like – cryptocurrency coins that have a relatively stable value compared to Bitcoin and other cryptocurrencies such as Ethereum, XRP, EOS, Cardano, Binance Coin, etc.

Oftentimes stable coins are backed by an asset (fiat or commodity such as precious metals or gold) or they can be algorithmic. Asset-backed stable coins are like an IOU, with an asset such as USD in a trust account with the issuer who then issues a USD-backed stable coin (examples in Tether [USDT] and Gemini Dollar [GUSD]). Algorithmic stable coins are still stable coins and have the same general concept, but the background activity/tech is more complex.

How Do Stable Coins Work?

As I alluded to earlier, stable coins work with cryptocurrency technology and exist on blockchain ledgers. There are two major types of stable coins, asset-backed and algorithmic.

Asset-Backed Stable Coins

Asset-backed stable coins tend to be “pegged” to another asset. Typically our current stable coins have been pegged to the US Dollar (USD). This means that for every “stable coin” in circulation on its blockchain, there is a USD in a holding account somewhere. There is a one-for-one relationship between the fiat dollars and the issued stable coin.

There are several types of asset-backed cryptocurrencies, most popularly the USD, but there are also gold back stable coins.

By their nature, these stable coins have assets that support their value. These assets must be held in bank/trust accounts to maintain the stability and consumer-trust in the stable coin. This brings up some conflict with the trustlessness of pure cryptocurrencies. Because current banks and trusts are private, these accounts would require periodic audits by professional auditors of various interest groups to confirm their holdings backing the stable coins.

While these asset-backed cryptocurrencies exist and are relatively successful thus far, it is not as transparent as the Bitcoin or Ethereum blockchains, and thus inherently less trustworthy.

There are many claims that because asset-backed stable coins have holding accounts they are centralized. However, just because a stable coin is backed by an asset does not automatically make it extremely centralized. It is possible that a stable coin is backed by assets that are stored in a network of decentralized vaults, accounts or holders. Yes, it is much more difficult to be decentralized and it’s impossible to gain the same degree of decentralization as Bitcoin (or Ethereum and XRP). But that does not mean that asset-backed stable coins have no role to play in this new cryptocurrency industry and in the global financial transformation.

Algorithmic Stable Coins

Algorithmic stable coins have no fiat or commodity asset backing them. The stability of the coin is derived from a set of rule written into the code that strives to match the supply of the token with the demand. So that if the demand increases, then the supply will increase so that the value of an individual coin does not increase. And as the demand decreases, then the supply will decrease so that the price of individual coins does not decrease.

I believe the most popular/successful example of this is the Maker DAI token, which uses both USD and collateralized debt positions (tokenized assets of real estate or other cryptocurrencies etc) to issue the DAI stable coin, which is pegged to the price of a USD (because the USD is still the world’s reserve currency).

The inner workings of the DAI stable coin and other algorithmic

Why Do We Need Stable Coins?

Stable coins are useful at this time in the cryptocurrency industry for a number of reasons. Stable coins are a gateway to cryptocurrency, they directly bridge fiat to cryptocurrency, creating a link from the old to the new. The old fiat is “sitting” in a bank account or trust account of the issuer of the stable coin and a one-for-one issuance of the stable coin is completed. Now, rather than a fiat dollar, it is a fiat stable coin dollar.

Secondly, It works the same as fiat and the general public would be more comfortable with this type of cryptocurrency initially. Third, the stable coin works on blockchain tech and it is thus exceedingly easy to send, receive, make payments, execute a settlement on a trade etc, introducing the public to the benefits of blockchain and cryptocurrency technology. Imagine making a donation to a charity for a recent earthquake – you can track on the blockchain that your money arrived at the destination with minimal fees and within hours, not days to weeks with numerous middlemen.

Stable coins would allow average consumers to go about their days paying their bills, buying their coffee, groceries and gas using secure cryptocurrency technology in a stable value currency such as a stable coin.

Perhaps one of the most important reasons to have stable coins is that since most stable coins are ERC-20 based, you can hold them in a cold hardware wallet, away from a bank and away from the government. It is like storing cash under your mattress, but rather you are storing it on your Ledger Nano X or your Trezor wallet. While that might not sound like a great benefit, it is a huge pro for stable coins. You can take your money worldwide without permission.

And the obvious reason why we need stable coins: Bitcoin and altcoins (i.e. ETH, XRP, BNB, EOS, ADA, etc) are highly volatile when compared to the USD. Having stable coins means that you can sell a position in Bitcoin or altcoins and hold the value in a stable coin as you wait for your next buying opportunity.

What Are The Different Types of Stable Coins?

Fiat-Backed Stable Coin

As the name describes, fiat-backed stable coins are backed one-for-one with a fiat currency, the most common being the USD since it is the world reserve currency. However, there are Euro-backed stable coins as well (UPEUR).

Fiat-backed stable coins require trust accounts and auditing to maintain trust in their collateral.

Commodity-Backed Stable Coin

Commodity-backed stable coins are backed by things such as gold, oil (i.e. the Petro, issued by the Venezuelan government), real estate etc. These require more complex coding and supply/demand adjustments. Commodity-backed stable coins also require auditors.

Cryptocurrency-Backed Stable Coin

Cryptocurrency-backed stable coins are very similar to fiat-backed stable coins, but rather than fiat dollars backing them there are cryptocurrencies backing them (such as ETH). The most famous of these is MakerDAO’s DAI token, built on the Ethereum network.

Cryptocurreny-backed stable coins have several advantages over fiat-backed in that they are much more decentralized, without the need for a custodian/trusted third party or auditors, and it has high liquidity.

The downside to cryptocurrency-backed stable coins is that they are much more complex with respect to their code and much more foreign to average people.

Seigniorage-Style Stable Coin

Seigniorage-style stable coins are truly algorithmic as they have no backing with real-world assets, claiming that if fiat can have no backing then so can cryptocurrency. I mean Bitcoin, Ethereum and XRP have no physical backing, just their network value, so why not have a stable coin cryptocurrency backed by faith in code?

Basically, this is like fiat currency, backed by nothing, but considered stable by supply-demand and by an authority.

Basis (basecoin) was one of the first such projects and was initially quite successful, but it was shut down due to regulatory constraints.

List of Different Stable Coins

Regulated vs unregulated (Tether) USD pegged stable coins. (i.e. USDT, GUSD, DAI, Libra, Basis, etc)

  • Tether (USDT)
  • True USD (TUSD)
  • USD Coin (USDC)
  • Gemini Dollar (GUSD)
  • Paxos Standard Token (PAX)
  • Libra (not yet released)
  • Petro

Tether (USDT) – Tether is a USD asset-backed stable coin, released in 2014 that is controlled and issued by the company Tether Limited. Therefore, Tether has a centralized authority. There has been much controversy surrounding Tether in 2019 owing to its change in terms and conditions stating that it can also be backed by loans to affiliated companies, particularly the Bitfinex cryptocurrency exchange, as well as Tether being resistant to third-party audits of its holdings. Despite this controversy, today it remains one of the most used USD stable coins with a market cap of approximately $4 billion USD. Despite being a stable coin, owing to its high market cap (and thus backing) it has been in the top 10 coins by market cap for a while. And it is the only stable coin within the top 10 cryptocurrencies.

True USD (TUSD) – True USD is another popular stable coin that is pegged 1-for-1 with the USD. It is a USD asset-backed ERC-20 stablecoin. They claim to be fully collateralized (unlike Tether), legally protected and transparent by allowing third-party audits. They use multiple escrow accounts to decrease counterparty risk in holding USD. However, the market cap for TUSD is ~$195 million, roughly 20x smaller than USDT. This may be due to the fact that you must go through KYC/AML to use TUSD via Bittrex.

TUSD Stable Coin

USD Coin (USDC) – USD Coin is another USD asset-backed stable coin, created by CoinBase, one of the largest cryptocurrency exchanges in America. It is backed by the USD and powered by Ethereum (ERC-20 token). USDC can be moved around the world at next to no cost, just like you would send Bitcoin, Ethereum or XRP. The market cap of USDC is roughly $420 million USD, approximately 10x less than USDT, but 4x greater than TUSD.

Gemini Dollar (GUSD) – Gemini dollar was developed by the Gemini exchange (Winklevoss Brothers) and is also built on the Ethereum network (ERC-20 token). Again, it is a USD asset-backed stable coin that has 1-to-1 reserves of USD, with USD held in the Gemini Trust Company LLC. Released in September 2018, GUSD is almost 1 year old, with a market cap of almost $7 million, it is one of the smallest stable coins.

Paxos Standard Token (PAX) – Paxos is another ERC-20 based USD asset-backed stable coin that is 1-to-1 with the USD. The USD are held by the Paxos Trust Company, which undergoes periodic audits, which they openly publish on their website. The PAX token has a market cap of roughly $193.6 million USD.

Libra – Facebook’s initiative fiat-backed stable coin. This is not yet released or live in any way. The Libra Association (initially consisting of 100 members, of which Facebook is only one) would monitor and control the issuance of the fiat-backed Libra. Libra supposedly will consist of a basket of the world’s largest fiat currencies such as the USD, EUR, GBP, Yen, & Yuan (unconfirmed).

Petro – issued by the Venezuelan government and backed by the nation’s oil and mineral reserves. It does not currently function as a medium of extra or currency in Venezuela since many of its citizens have flocked to Bitcoin.

The Problem With Fiat-Backed Stable Coins

The main problem with USD (or any fiat) pegged stable coin is that it is based on the fiat system of low-interest rates, high inflation and long term devaluation of national currency. This destroy’s peoples’ savings and makes investing and living a financially stable life very difficult.

The entrance of Bitcoin in 2009 is deemed to have been in response to the global financial crisis and avoiding the traps of fiat by creating digital hard money, that holds its value and even increases as value is created in the economy.

I think that USD pegged stable coins will serve a purpose and will help bridge the world into the cryptocurrency space, bringing finance into the 21st century and the Age of the Internet. Eventually, my guess is that governments will simply issue stable coins in the form of Seigniorage style stable coins… essentially crypto native fiat. This will not solve the problem of their overprinting of fiat, inflation and currency wars… it just empowers them to do it more effectively.

The Future of Stable Coins

Stable coins will be present in the future. They are an entrance for average people into cryptocurrency and allow people to transact in their daily lives without worries of volatility.

Stable coins will soon be regulated and my guess is they will also be issued by governments around the world. The Chinese government recently reported that they have been developing their own nationally issued stable coin based on blockchain and cryptocurrency technology. They may very well be the world’s first government adopted and issued fiat crypto-stable coin.

Personally, I think that stable coins will permeate the world as consumers, businesses and governments are used to transacting in more stable values. Stable coins are the flip and transition from fiat to cryptocurrency.

First, stable coins will be backed by USD or other national currencies. Then with time, governments will simply issue stable coins directly as fiat, not requiring any backing (much like paper fiat today is issued).

What is the Difference Between a Stable Coin and a Native Cryptocurrency?

The difference between a stable coin and a native cryptocurrency is that the stable coin derives its value from the backing of an asset, whether it is USD, gold, oil or a basket of fiat currencies, or even a basket of collateralized debt obligations or other native cryptocurrencies.

Native cryptocurrencies do not require backing as their value is derived from the network effect of their usage, immutability, worldwide integration, security, open/public ledger and censorship resistance.

References for “What Is a Stable Coin?”

  1. Stablecoin – Wikipedia
  2. Explaining Stable Coins, The Holy Grail of Cryptocurrency
  3. What is a Stable Coin – Toshi Times
  4. Cryptocurrency 101: What is a Stable Coin?
  5. Stablecoins, Explains – Coin Telegraph
  6. What is a Stable Coin? – Cryptocurrency Facts
  7. What is a Stable Coin? – Mycryptopedia

Click here for more on “What is Cryptocurrency”.

Markshire Crypto Conclusion on Stable Coins

I believe that stable coins are just beginning. I think that we will witness the development of many more stable coins over the next decade. The stable coins, in my opinion, are part of the bridge between our old world of finance, into the digitally native blockchain world.

Soon certain stable coins won’t be pegged to fiat, they will BE the fiat. Governments will issue government fiat currency as stable coins. This is all part of the transition occurring subtly before our eyes. You must look carefully, but you can see the transition happening.

As Andreas Antonopoulos says on his talk on How Things Change, the new system must ride on the rails of the old system, and slowly demonstrate its superiority and slowly the change/transition will occur more directly to the newer, better system, in this case, native digital currency or cryptocurrency.

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Author: Markshire Crypto

Millennial cryptocurrency investor, writer and marketplace researcher. Founder of Markshire Crypto. Mark has been involved in the cryptocurrency industry since 2017, following the industry daily and creating content.

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