Cryptocurrencies with volatile prices might attract investors seeking a quick profit (or loss), though several new digital currencies have debuted with the promise of retaining a fixed price.
These are stablecoins – digital currencies that are pegged to the supply of an underlying asset to retain their stability while harnessing the utility of blockchain technology.
As Sherman Lee best explained, “A stablecoin is a cryptocurrency that is often pegged to another stable asset, like gold or the U.S. dollar. It’s a currency that is global, but is not tied to a central bank and has low volatility. This allows for practical usage of using cryptocurrency like paying for things every single day.”
Principally, there are two forms of stablecoin – one is fixed to the price of fiat currency or an underlying physical asset such as gold or oil, while the other relies on another cryptocurrency – or several – as collateral.
Tether stands as potentially the most successful stablecoin to date, and is pegged to the value of the US Dollar on a 1:1 ratio.
With a market cap nearing the $2.3 billion USD mark, Tether has seen wide adoption from a range of cryptocurrency exchanges seeking to use the stablecoin as currency against other tokens where direct USD purchases are not feasible.
Tether has attracted its share of criticism, however, as several critics have questioned the company’s lack of transparency, financial standing, and terms of service.
The centrality of the stablecoin has also been brought into question, given that $30 million USDT were recently plundered as the result of a hack.
Another Dollar-pegged stablecoin, USDX aims to resolve several of the pitfalls that involve using fiat currency as an underlying asset.
In contrast to Tether, USDX generates its supply by means of a proprietary algorithmic bank that can expand and contract its supply to match the US Dollar’s value.
USDX, under the direction of its Singaporean founders, is now aiming to leverage other fiat currencies as its underlying collateral as opposed to just the US Dollar.
While DAI is pegged to the value of the US Dollar, the stablecoin project employs an interesting mechanism to maintain fungibility.
While foul play might remove fiat currency from a monetary system – and hence compromise the supply of a pegged stablecoin – DAI leverages smart contracts and the price of Ether to maintain its value.
To acquire DAI, users ‘lock up’ Ether as collateral within the Maker system. When returning their DAI, users are awarded the same amount of Ether as they initially put up as collateral.
DAI leverages automated liquidation process; locked-up Ether is proactively auctioned off before it drops below the quantity of DAI it backs.
While Basecoin has launched pegged to the value of fiat currency, the initiative has garnered acclaim for its long-term decision to peg to an index of underlying assets.
Basecoin’s ultimate goal will see the project to an index-offering, wherein the project will aim to ensure its stability by pegging its value to a multitude of assets.
Additionally, Basecoin leverages two additional currencies to maintain its supply. Basecoin holders can sell their Basecoins for Bascoin Bonds to gain interest on their investment, and Basecoin Shares are issed when the stablecoin’s supply must be expanded.
Arguments for and against stablecoins
While one might think that the stability of fiat currency and the utility of a cryptocurrency might be a match made in heaven, stablecoins have polarized early investors.
Proponents of stablecoins have argued that, in theory, perfectly engineered projects are a crucial link in fulfilling all the major properties of a currency – serving as a medium of exchange, store of value, and unit of account.
While cryptocurrencies such as Bitcoin might offer an enticing form of currency that may be adopted in the future, a chief barrier in the choice of users and merchants in doing so is inherent volatility.
Put simply, if Bitcoin could not sustain a relatively stable value for a reasonable period of time, it would not be feasible to price goods or accept Bitcoin as a currency in exchange for services renders.
Stablecoins, then, offer an attractive alternative – as they leverage blockchain technology to harness all the properties of a cryptocurrency while retaining the stability of fiat currency or a natural asset.
Conversely, stablecoin detractors have argued that inflationary currencies – such as the US Dollar – are not worthwhile collateral and, as such, stablecoins are inherently replicating a problem that deflationary cryptocurrencies such as Bitcoin can solve.
Further, critics have argued that a fiat-pegged cryptocurrency would simply be another financial derivative, which could be subject to a nation’s legal tender laws. Hence, a stablecoin may at most be stable in purchasing power and not inherently stable against the basis of its underlying collateral.