Stablecoins – cryptocurrency coins and tokens that are designed to maintain a steady price – have been around for a couple years now. Typically, stablecoins are tied to the value of a popular fiat currency such as the US dollar.
In times of turmoil when markets are dropping, historically stablecoins have generally managed to maintain their value. Conversely, when the market is booming, stablecoins do not see any upward price movements by design.
But with one of cryptocurrency’s main attractions completely out of the picture, namely the long-term trend of prices moving upwards, why would anyone be interested in stablecoins?
While these assets have become popular recently, do they have any future in the long-term, or are they just a passing fad? Join us as we go over whether or not stablecoins matter for cryptocurrency in the long-term.
The first thing we need to understand is how do these coins maintain their steady prices. Each one is slightly different in how they operate but there are two main methods that most assets are using.
The first and easiest to understand is the cash reserve model. Under this design, a central group, company, or nonprofit will claim to have a reserve of a national fiat currency in their accounts. For each coin released, the group that created it will claim that each is fully backed by an equivalent amount of fiat currency.
In some cases, the operators of the project might offer to trade stablecoins for fiat currency on request. This type of design is reminiscent of the classic idea of the gold standard, where banknotes would be tradable for gold on-demand. But instead of gold, these projects rely on national currencies whose values can also rise and fall depending on economic movements and trends globally.
The second most common model is quite a bit more complicated and relies on smart contracts that act automatically to incentivize individuals to trade the asset in such a way that the price stabilizes. The design behind these types of systems is so complicated, however, that it is beyond the scope of this article. Needless to say, these systems rely on technical means of manipulating incentives.
Who is Using Stablecoins Now?
Since stablecoins are fairly popular now, one obvious question to ask is who is using them, and why?
While this is difficult to verify due to the anonymous and decentralized nature of cryptocurrency in general, the common assumption is that stablecoins are currently a preferred means of locking in trading profits without needing to interact with banks and fiat currencies.
Here’s an example of how this might work. Let’s say that a trader bought some bitcoin at $5000 and sold it later at $8000. This trader suspects that the market will drop again in the next month. If they were to simply hold onto the bitcoin, they could see a loss in their equivalent fiat value.
In order to lock in this game, they have two choices. One would be to sell their bitcoin for fiat currency, and the other would be to sell their bitcoin for another cryptocurrency. In this case, stablecoins can make a lot of sense. If they are able to consistently maintain their value, selling a volatile asset (one whose price changes regularly) into one that is stable, then your gains can be protected from market movements.
But why use stablecoins and not simply sell for cash? This one comes down to convenience and ease of access. Trading one cryptocurrency for another is a fairly painless and often instantaneous process. Banks, on the other hand, may come with fees, delays, and other problems. In some extreme cases, some banks have been known to blacklist or ban accounts that have been detected doing business with cryptocurrency exchanges, though this is still somewhat rare.
Lastly, if our hypothetical trader decides to buy back into cryptocurrency, that action can once again be completed almost instantly if we are buying from stablecoins instead of from a bank account. With a bank account, we would need to wait for an ACH, wire transfer, or similar bank transfer which could take days or more and potentially come with a fee.
Not Just for Traders
Another growing industry in the cryptocurrency field is crypto-backed loans. One provider, Nexo, offers what is essentially a loan that is backed by deposits made in a supported cryptocurrency.
Let’s say for example that you need to buy a new car, but most of your savings are tied up in Ether. You could sell your Ether, but this will incur capital gains taxes, and you may end up missing out if Ether prices shoot up after you sold.
Crypto lending services allow people to deposit cryptocurrency and receive fiat currency at a very low interest rate (since the loan is fully backed by your deposit, meaning virtually no risk for the lender). When taking out a loan, Nexo allows borrowers to choose to receive funds in the form of stablecoins.
Some borrowers may be forced to receive their loan in stablecoins if they live in a country with limited banking access or have other banking-related hurdles such as excessive regulation.
Stablecoins and the Big Picture
Now that we have some background on what stablecoins are and a few examples of who is using them, we now need to ask ourselves: where are stablecoins going, and what kind of impact will they have on cryptocurrencies in the future?
The first and most likely way that stablecoins could have a positive impact on cryptocurrency adoption is through consumers and end-users.
Recently, Facebook announced the pending formation of their own stablecoin cryptocurrency that will be tied to the US dollar, currently known as the Libra. The idea behind Libra is that Facebook wants to make it as quick and painless to send money as it is to send a text message.
Since the value of Libra does not change from day to day, it cannot be considered an investment and thus may be able to avoid some amount of financial regulation (but this is yet to be seen).
Mobile-based cash transfer apps like Venmo have grown rapidly in recent years thanks to their convenience and very low fees. It is reasonable to predict that either Venmo or something like it could use stablecoins in the background, thus limiting interactions with banks and reducing their subsequent fees. It may even be possible that this is already happening and we just don’t know it yet.
Looking farther afield, one futuristic application for stablecoins comes to mind. Specifically, international currency exchanges are still a major hurdle when it comes to doing business across national borders, or even just traveling to another part of the world. Banks and moneychangers charge hefty fees to exchange currencies before travel. And while some credit cards allow for no international transaction fees, not everyone has access to these as they typically require fantastic credit scores and steady income.
Suppose then, for a moment, that a sort of universal payment app or card were to be created that relies not on fiat currency, but on a stablecoin that is highly liquid and easy to buy and sell into and out of local currencies.
Such a stablecoin would prevent the issues related to volatility that bitcoin suffers from, while allowing for greater ease-of-use and near global application. One obvious problem with this that would need to be addressed, however, is How the network would function in terms of network transaction fees and or the network protecting itself from spam attacks.
One final use case for stablecoins that we would like to discuss here is their potential application as a sort of reserve currency. The number of companies offering interest to customers that deposit cryptocurrency with them is growing. These companies seem to show a particularly strong interest towards accepting stablecoins as they often garner higher interest rates than more volatile assets like Ether and Litecoin.
For example, as of press time, Celsius Network is offering close to 11% interest per year on a handful of stablecoins. Nexo, which offers a similar service, is currently offering 8% interest on 8 different stablecoins.
It is impossible to know if this high interest trend will continue into the foreseeable future. But if it does, stablecoins could become a new and realistic alternative to making bets on the stock market, or leaving money in a bank only to earn less than a fraction of a penny on every dollar saved each year.
Stablecoins have been around for a few years, which in cryptocurrency terms is practically a few eons. However, we still don’t know exactly where this novel asset class is going or where it will bring us.
Regardless, the number of potential applications is compelling and it’s likely that these assets won’t be going away anytime soon.