Price volatility of cryptocurrencies has led to the inability to confidently use them as an instant and seamless medium of exchange. A key hurdle for more mainstream adoption of cryptocurrencies is being able to come up with a solution that solves this problem that deters many people from using them for one of their original novel components. This has led to a rise in a number of projects known as Stablecoins that use their own methods for achieving price stability within their currencies while also retaining the key components of cryptocurrencies that make them distinct and novel technologies.
What Are Stablecoins?
Different platforms implement a variety of different methods for achieving price stability. Many of these platforms peg the value of their currency to a fiat currency in some form another such as the US Dollar. Whether they use a proprietary algorithm for managing price movements, are purely backed 1:1 by an established store of value, or function as a decentralized organization, the number of different stablecoins in the industry has been growing.
Achieving a decentralized stablecoin is the goal. The most prominent and widely used stablecoin is Tether, which is backed completely by fiat currency, but it is centralized and has been highly scrutinized throughout its existence. Promising projects have presented their platforms that take some unique approaches with some innovative mechanisms, however, a proper solution that is widely accepted by the larger community as functional, secure, and sufficiently decentralized has yet to come to fruition.
The Importance of Stablecoins
The importance of a stable cryptocurrency cannot be understated and is considered by many to be a crucial element of the broader cryptocurrency industry for a number of reasons that range from more pressing needs in the current climate to impacting how the industry develops over time. Specifically, the key is stability and there are two components that are essential to understand. They are short-term stability for transactions and long-term stability for holding as an investment.
While the volatility of cryptocurrencies is attractive to investors looking to make both short-term and long-term gains, stability provides a vital role in investing. When there is a bear market like seen over the first 3 months of 2018, investors look for stable stores of value to keep their funds while prices fluctuate and many of their investments post significant losses. Since it is relatively difficult still for the average user to convert fiat money to cryptocurrencies and back again, having a stable store of value in a cryptocurrency itself becomes paramount to mitigating losses during such markets.
Additionally, many users still keep their money on exchanges for short-term trading, and the ability to get in and out of a trade while feeling satisfied that your money is not susceptible to fluctuations if you step away from the computer for a few hours is highly relevant. Most cryptocurrencies on the largest exchanges are pegged to Bitcoin and Ethereum so when the market is trending downwards, they also trend downwards, leaving a pressing need for a stable store of value.
The more significant issue facing cryptocurrencies that stablecoins aim to provide a solution for is short-term transactions. With Bitcoin, one of the most decisive aspects of the technology was its ability to function as a “Digital Cash”. Numerous examples from books and articles describing Bitcoin would use buying a cup of coffee as an example for how a simple transaction with your wallet worked and subsequently how it was propagated across the network. Unfortunately, this is no longer cost-effective as the price of Bitcoin is highly volatile itself and with small purchases, it is simply not efficient or convenient for an average person, who cannot withstand the volatility, to use for small transactions.
This has created a problem in the industry, as many platforms offer a variety of new technologies and environments for decentralized applications, one of the core tenets cryptocurrencies remains an unresolved issue. With more and more cryptocurrencies entering the market, many have focused specifically on stablecoins and providing the right solution to an important problem. Below you will find a variety of stablecoins either fully functional today, or developing their platforms with some promising ideas.
Tether is the most well-known and adopted stable cryptocurrency that is available as a trading pair on numerous exchanges. Functionally, it is backed completely by fiat currency with 1 USDT equal to 1 USD. This means that Tether (which is a company) is a centralized repository of a digital currency representing the US Dollar. So, they need to maintain at least a 1:1 ratio in their bank of USDT/USD, or have slightly more USD than USDT in circulation for their stablecoin to be considered valid.
This has not come without controversy though as many people are against the idea of a centralized authority being behind a stablecoin. Additionally, Tether has faced accusations that they do not have the requisite funds in their bank account to back the amount of USDT in circulation. Regardless, Tether remains the most popular stablecoin today despite its perceived shortcomings.
Basis is a new stablecoin on the scene that made waves with its recent $133 million investment from major VC firms. With major financing and backing behind the Basis team, it is inevitable that expectations will be high and their platform highly scrutinized, which it already has been by some.
Basically, Basis uses an “Algorithmic Central Bank” that functions within the confines of the simpler paradigm of supply and demand. So, while demand rises, more Basis is created and the price decreases. When demand is falling, the blockchain will buy back Basis, decreasing the supply and increasing the price. This implementation remains contentious, but is based on a fairly simple concept and its actual functionality has yet to be scrutinized.
MakerDAO is a very interesting stablecoin concept as it functions as a Decentralized Autonomous Organization (DAO). The model is pegged to the US Dollar but completely backed by Ether. Through utilizing smart contracts, Maker uses a two coin system where the coin Dai is the stablecoin pegged 1:1 with the USD.
MakerDAO is a solution focused on leveraging the potential of decentralization to create a stablecoin. It is one of the first coins to focus on a stable currency and provides a fascinating concept. Criticisms of the platform revolve around it being too complex with DAOs themselves not fully investigated enough act as such a platform.
Carbon is another stable cryptocurrency project that relies on using smart contracts and algorithmically adjusting the value based on it being pegged to the US Dollar. The project places an emphasis on high-throughput transactions, a trustless model, and “programmable money” through the ability to apply context to transactions by utilizing smart contracts.
The project is very new, but it has a strong academic team behind it with experience from some established companies. As the project continues to develop, it will be interesting to keep an eye on.
Havven is a fork of Monero that has a focus on providing stability while also adding the anonymity-centric features of a privacy coin like Monero. Havven also uses an on-chain smart contract. The currency is not pegged to anything or backed by an asset, but rather is designed to be fully functional through leveraging the smart contract to mint and burn coins.
It uses game theory mechanics and a stable coin for use as a sort of collateral while also allowing users to be able to transact fiat currencies that are exchanged prior to a transaction. The two-token system includes Nomins and Havvens with Nomins being the the stable coin with a floating supply while Havvens act as the reserve currency of the platform.
The interest and motivation to create a functional and decentralized stablecoin in the cryptocurrency space remains despite their polarizing nature. Many see them as impossible to operate effectively without connection to a third party, inherently making them ill suited for the industry. Others see them as a solution to a fundamental problem in the markets and use as a stable store of value that opens the door for mainstream users to feel confident they are not using a highly volatile digital currency for their small day to day transactions.
People are hesitant to move away from traditional fiat currencies and enter the cryptocurrency realm because they simply don’t understand them or are scared of their volatility. The ability to bridge that gap with a stable currency that is a cryptocurrency, is a major opportunity for more wide scale adoption and transition from established models. Whether another solution outside of stablecoins can bridge that gap, or a sufficient stablecoin comes around and offers the solution, is yet to be seen.