Strong and Stable[coins]
What are they?
Stablecoins are a subset of cryptocurrencies and were created to harness the benefits of digital assets whilst mitigating against the price volatility. Traditional cryptocurrencies such as bitcoin and Ether can see large intraday price swings, which could mean you pay the equivalent of £2 for your coffee in the morning, but by the end of the day the same coffee could cost £4. The volatility of bitcoin can be seen in the below chart, as well as by comparing the price on the same date across the last 4 years:
N.B in December 2018 it reached a peak of almost $20,000.
any claim that this makes cryptocurrencies, in their current state, unsuitable as a means of payment and as such, the concept of a stable coin was borne.
There are broadly two categories of stable coins: asset-backed and algo-backed. Asset backed coins can be pegged to a traditional asset such as gold or fiat, or even to another crypto.
Traditional Asset Backed
These stable coins are modelled on a previous financial system in which paper money represented a gold deposit held by a central bank. This acted as a more efficient way of moving value round the system rather than attempting to physically move gold across owners. The holder of the paper money could, at any point, request gold of the same value from the bank and therefore the paper money was a promissory note rather than an item of value in itself. This is why paper money today still bears the message:
“I promise to pay the bearer on demand the sum of ‘x’ pounds”
Similarly, asset backed stable coins are pegged 1:1 with an asset which can be held in reserve, whether this be USD, grain, fine wine or art (N.B 65% of fiat pegged stable coins are with the US Dollar). As such, the creation of any new crypto must be supported by placing additional assets in reserve in order to maintain the 1:1 peg. Examples of this are Tether (USDT) which is backed 1:1 with USD, or Digix (DGD) which is backed 1:1g with gold. The stability of the coin price is therefore achieved through the manipulation of token supply — between the value of the fiat held and the coins placed in circulation. Owners of the stable coin should be able to exchange their coins 1:1 with the pegged asset e.g one USDT gets you one USD and visa versa.
The main point of criticism raised against this form of stable coin, and Tether most specifically in the media, is the importance of trusting that deposits have been made. If, for example, Tether was not placing an equal amount in reserve, then the pegging would be illusory and if all users wished to withdraw their USDT for USD, the system would collapse since sufficient funds would not be available. Audits on the reserved funds can go some way to enhance this trust but require a reputable firm who is able to analyse across both the traditional fiat and blockchain spaces.
Recent notable fiat-backed stable coin projects are the launch of Circle’s USDC in September 2018, backed against the US Dollar, and the January 2019 announcement by PwC and Cred around their joint stable coin project. However by volume, the most notable fiat backed stable coin is Tether with $9.8bn 24h trading volume. This is followed by TrueUSD at only $130m 24h trading volume and a market cap just inside the top 30 cryptos.
Crypto-Asset Backed
Similar to traditional asset backed stable coins, crypto asset backed coins take their value from an underlying asset, in this case another cryptocurrency such as bitcoin or Ether. They can’t be held 1:1 due to the volatility of crypto therefore a more creative solution is required. An example of which is the MakerDAO project (https://makerdao.com/en/dai) with their stable coin dai. This is based on the idea of collateral debt positions where the user receives dai for sending another cryptocurrency as collateral (e.g allowing Maker to custody it). As such, they can exchange dai for fiat on a number of exchanges or return the dai for their collateralised asset. The rates for this are controlled by Maker in order to stabilise the value of dai and therefore allow it to act as a stable coin.
Another example of a crypto-backed stable coin is the recently announced Wrapped BTC (WBTC). This is an ERC-20 token which leveraged atomic cross-chain swaps — the ability to ‘move’ coins from one protocol to another — and as such, BTC is held in custody on the bitcoin blockchain with a 1:1 amount of WBTC being released to the user on the Ethereum blockchain. The project’s aim is to improve liquidity on Ethereum and provide a more decentralized and transparent stable coin (as reserve positions can be audited on the public ledger).
Both these projects hold currency risk since the collateral is in one cryptocurrency (ETH for Maker and BTC for Wrapped BTC) therefore allowing a greater diversification of collaterals would reduce this risk. However, despite the volatility of the underlying asset, since it is a crypto, dai’s price chart shows impressive price stability (green line):
and although WBTC is in its infancy, so far it looks to be holding around the 1BTC mark (orange line):
Supply Algorithms
This stable coin type uses an algorithm to match supply and demand, burning/locking up or creating tokens to ensure price stability.
“Think of this as an automated central band that enacts monetary policy through programmatic capital controls”
https://medium.com/fluidity/stablecoins-ea7fc5a8740d
An example is NuBits which was created in 2014 and is pegged 1:1 with the USD. It attempts to stabilise price by distributing voting shares (NuShares) as well as the native current NuBits. NuShares entitle the owner to vote on motions and network changes as well as earning them incentives to stabilise the network such as dividends. NuBit owners can redeem the coin on an exchange for USD or lock them up to gain interest — thereby reducing the circulating supply and helping to maintain a stable price. Although NuBits initially maintained its price, a significant drop in late 2016 was later followed by a 30% drop in March 2018 and then sustained price depression (green line):
Another notable algo-backed stable coin project, Basis, raised $133m in 2018 but later closed down the project due to ‘regulatory difficulties’. It’s therefore clear that creating an algo backed stable coin is a complex undertaking and ensuring the algo can adequately match supply and demand is not straightforward. However, since every adjustment is made on-chain it does carry benefits of decentralization and transparency. There is also no demand for additional collateral since the price is stabilised by creating or destroying coins.
For more information about stable coins I would recommend this in depth report from Blockchain — 2019 State of Stablecoins: https://drive.google.com/file/d/1J5YOUYBJwbeJp6rH9uSBLjmZUvub6qyv/view
