An Introduction to StableCoins

The cryptocurrency space has seen a huge expansion of stablecoins in the past year. Almost 40 different projects are currently live and many more are being created. $330 million of funding has been raised for projects in the space and stablecoins currently represent over $3 billion in market capitalization as of December 2018. While this is roughly only 2% of the total crypto market cap, stablecoins represent 26% of the daily trading activity. These types of tokens demonstrate more than just a minor use case for blockchain technology, but have utility that is expected to grow exponentially as the crypto ecosystem matures. Although there is enough room in the market to support many stablecoin projects, there is an arms race is taking place. Which business model is the strongest and can weather the volatile nature of the crypto market? Only time will tell.

What is a Stablecoin? Why Should You Care?

The first wave of live stablecoins was launched back in 2014. Though the idea of a stablecoin is not new, many different models have been coming out to offer the same value proposition. Its purpose is simply to maintain price stability in reference to another value — in many cases the US Dollar. As many of us probably know, price volatility cuts both ways — up and down, good and bad. Many people see crypto as an extremely volatile asset class, which makes it very difficult to assess the actual value of any protocol. Stablecoins attempt to combat this problem and provide a blockchain-native solution to preserve value in crypto for various purposes and use cases.

For a consumer, stablecoins represent the bridge between traditional transaction-based methods to an emerging technology while still maintaining a consistent, pegged value. In this context, it’s easy to recognize why has there been so much attention and fundraising for these stablecoins. The adoption of blockchain technology is already happening, with stablecoins providing the most relevant use cases to disrupt lending, payments, remittance, and financial services in a more transparent, efficient, and ease-of-use manner.

What Makes Stablecoins ‘Stable’?

There are many different ways a token can maintain its currency peg properly, and below is a broad highlight of the many stablecoin models out there.

From Blockchain’s State of Stablecoins Report

  • The traditional (fiat-backed) stablecoin: A token is issued for every associated real dollar value that is collateralized against it. Some notable coins that utilize this model are TrueUSD and USD Coin.
  • Crypto-collateralized stablecoins: These issue tokens from a source that is natively backed by the value of another cryptocurrency. Examples of crypto-collateralized stablecoins are Dai, part of the MakerDAO system, and BitUSD.
  • Algorithmic (or elastic) stablecoins: These coins have no collateral backing the currency, but instead use a variety of actions to control supply and maintain the reference peg. There hasn’t been a live algorithmic stablecoin that has successfully maintained its value in the markets, though large amounts of funding have gone into investigating this concept into projects like Carbon and Ampleforth. Presently, these projects face a sleuth of regulatory and legal uncertainties.

Many stablecoins do deviate slightly from their reference peg in terms of price, but this is as a result of actions from real-world activity such as transfer fees, trading activities, and counterparty risk. Since rational arbitrageurs are willing to trade into the perceived value of the stablecoin, removing discrepancies based on market conditions, this is viewed as temporary.

What Can Stablecoins Do?

Store of value and medium of exchange is the most common utility associated with stablecoins. They are also a prime use case for a variety of dApps to offer growing crypto-lending and remittance services. Almost 30 million USD of lending activity was seen in protocols in November 2018 alone.

Many popular stablecoins are ERC20 (a rule set for tokens on the Ethereum blockchain), so programmability as well as community support help the development of a stablecoin ecosystem. Because of such digitization, transfers of value can and generally are more transparent, quickly verifiable, efficient, and secure to move around.

What’s Next for Stablecoins

There are various dimensions that a stablecoin can be evaluated on, and we can observe the confidence people have associated with specific stablecoins by the market activity in terms of the price. Every stablecoin and their model has varying levels of transparency, whether it be on the process (on-chain collateralization, smart-contract issuance) or to inspect the collateral backing the crypto. The actual stability of a stablecoin and its scalability have also been debated upon on the best token model, with the more decentralized and scalable the more likely a stablecoin tending to be more volatile and lose its peg. Compliance has been a hot topic in conjunction with redeemability of a stablecoin into fiat. Security is also of importance for a stablecoin to properly preserve its value. Lastly, possible inclusion of pricing oracles, pooled collateral, or interest yield in the design itself may influence public opinion about how credit-worthy and beneficial a stablecoin can be.

Empirically, fiat-backed stablecoins are valued at a premium and observe less price volatility than crypto-collateralized stablecoins. People trust the concept that they should be able to redeem and maintain consistent value between the tokenized and fiat world. Progressions for easier redeemability can be refined over time, and the centralized controls (along with KYC/AML) are presently viewed as a positive when it comes the acceptance of regulation and attestation of fiat-backed reserves. The benefits of crypto-collateralized models are the possibility of increased scale and adoption, as well as the avoidance of any centralized authority to stop activity or block consumer funds. However, consumer confidence views the existing frameworks for crypto-collateralized stablecoins as risky due to lack of price stability against adverse market movements.

Simplicity and transparency traits are more niche offerings: Tether currently dominates the majority of stablecoin market activity but is quite opaque on its design. However, this trend could change depending on consumer confidence on other emerging stablecoins. Many stablecoins have not yet explored code licensing or provide accessibility to third-party use cases, such as additional wallet support. This should expand as the ecosystem develops to bring in more dApp activity.

Where the algorithmic/elastic stablecoin model is concerned, it should prove interesting to see whether the value proposition holds in the market.

There’s no question that there is still much experimentation to be done, but it is clear that stablecoins are popularized to create innovative monetary standards — and there is strong belief that the market will support many different varieties. Stablecoins are structural in the adoption of digital currencies and have many tangible use cases. These are all reasons for investors and spectators alike to get excited about participating in this transformative movement. As a matter of fact we are about to enter the ring very soon, referencing a different design with our own clever approach. We gathered feedback on the best features of what makes a stablecoin great, and we’re creating one that will be a major improvement over what is available today with a real advantage over any possible newcomers in the future.

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