The Rise of Stablecoins
The crypto boom experienced at the end of 2017 coupled with the crash of 2018 caused massive damage to the reputation and adoption process of cryptocurrencies around the world. Companies such as Microsoft discontinued Bitcoin payments for its products and services after the wild volatility period.
This showed that speculation is still the key driver in the industry which causes mad swings hence keeping most people away from investing/adopting the digital assets for daily use.
“Every dark cloud has a silver lining.”
The increasing volatility however brought about an influx of a different kind of digital asset in the market, stable coins. Before 2017, there existed only one well-known, Tether (USDT) which compares poorly to the current array of stablecoins available in the market at over 50 projects.
We offer a clear understanding of their workings in this article;
What are Stablecoins?
Stablecoins represents a newer form of cryptocurrency that is usually pegged to another asset such as fiat currency (USD, GBP…), a commodity (Gold, Real estate etc.) or another cryptocurrency to minimize volatility.
Stablecoins solves the volatility problems present in crypto while offering decentralized, transparent, secure, private features that cryptocurrencies enjoy. It offers stability and a low-risk investment in
cryptocurrencies. Their value lies in their ability to store and efficiently transfer rather than grow wealth, and they bridge the gap between physical and digital currency.
The first concept of stablecoins appeared back in 2013 as Tether (USDT) launched its digital asset along with BitUSD. More stablecoins have appeared over the years offering unique features to the cryptocurrency industry. Today, a total of 57 reported stable currencies projects are being built or are running around the world as the “stablecoin invasion” takes over.
Types of Stablecoins
Stablecoins are majorly categorized into two: collateralized and uncollateralized stablecoins. Collateralized stablecoins are reserve-backed by real-world assets (fiat or commodities) or backed by other cryptocurrencies, while uncollateralized are pegged algorithmically.
1. Collateralized Stablecoins
The most common type of stablecoins is collateralized. There lie two main categories of collateralized stablecoins namely fiat-backed and crypto-backed stablecoins.
Fiat-backed stablecoins are backed at a 1:1 ratio with a currency, meaning 1 stablecoin is equal to 1 unit of fiat currency (USD, GBP, CHF etc.). The entities that manage such stablecoins have a bank reserve for the currency units that is equal to the total number of cryptocurrency units in circulation.
For most of the fiat-backed cryptocurrencies, users are offered the option to transfer their digital assets for the currencies directly if they wished. One major advantage of such digital assets is the stability it offers so long as the economy of the currency remains strong even if the cryptocurrency world plummets to nothing.
Below are some of the major fiat backed cryptocurrencies.
Tether (USDT): $1,854,284,741 USD (8th)
Tether (USDT) is pegged to the US Dollar at a ratio of 1:1 on Omni blockchain. The largest stablecoin in market capitalization has been one with a ton of controversies in the last year regarding the reserves Tether has to back up the current 1,856,421,736 USDT circulating tokens. This comes as multiple requests by investors of Tether to show their audits have not been met.
The coin has been stable through its course of life with minor blips as seen above. USDT currently trades at $0.998849 USD.
Other USD backed coins include TrueUSD (TUSD) and USDC (USDC) by Circle and traded on Coinbase exchange.
Rockz (ROCKZ): ICO period
Rockz is a Swiss currency based stablecoin that equates to 1 coin for every 1 CHF. Rocks, termed as the ‘world’s most bulletproof cryptocurrency’ offers great stability for its users as every ROCKZ is backed by Swiss Francs reserves. ROCKZ is currently raising an ICO on its site.
A plethora of fiat-backed cryptocurrencies exist around the world including the London Block Exchange (LBXPeg) pegged to the GBP and Candy, a Mongolian tugrik backed cryptocurrency.
These refer to digital assets that are backed by cryptocurrencies in a move to reduce the volatility witnessed across the market. The continued contraction in the market in the last 2-3 months has shown the importance of stablecoins as the only digital assets to maintain a reasonable level during the capitulation of the cryptocurrency market.
The DAI is a crypto-backed crypto that is issued by MakerDAO platform whereby 1 DAI will at all times be equal to 1 USD. The stability of the price of DAI is market driven and realized by modifying the incentives to create DAI — if the price falls below the targeted 1 USD, the cost of creating new DAI increases, while in the case the targeted price is exceeded, the cost of creating DAI reduces. This maintains the supply of DAI.
More on Crypto-backed stablecoins here.
Gold, real estates, silver, oil, and other precious assets have long been used as a collateral for real USD value through collateralized loans and bonds. Such commodities have also been introduced to the cryptocurrency industry to back up some stablecoins including Digix Gold (DGX), Petro Currency and Tiberius Coin (TC).
2. Non-collateralized Stablecoins
Also known as seignorage coins. These are stablecoins that are pegged to an algorithm rather than an asset as the collateral-backed stablecoins. The algorithm involves maintaining an equilibrium in the supply-demand aspects of the coin. A good example of a seignorage coin is Basis, formerly known as Basecoin.
When demand is rising, more Basis will be created to match the supply to demand and when demand falls more Basis is bought back to maintain equilibrium.
Limitations of Stablecoins
Apart from the regulatory pressures faced by all coins in the market, stablecoins face an unsystematic challenge that poses a huge risk to its future prospects. Scalability is an issue that has troubled the early starters in the blockchain industry but is even persistent in these currencies. For reserve-backed stablecoins to reach a level where liquidity is deep enough to support interesting applications of the technology, backers will have to invest millions or even billions in each coin.
According to Garrick Heilman, head of research at Blockchain cryptocurrency firm and author of a report on stablecoins, the scalability problem will escalate as the industry grows.
“This could create “a cap on how fast the stablecoin can grow,” Heilman said. “When you’re talking about use cases in the trillions, having any upward limit or friction on how quickly something can grow is potentially a huge problem.”
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