Stablecoins have existed in the cryptocurrency space for a few years, but only gained prominence in the last year or so. Stablecoins are cryptocurrencies that are backed by other assets or benchmarks, such as the US Dollar, and, as the name suggests, they are stable in nature — or are at least intended to be so. Bitcoin is known for its volatility and that has led some people to believe that, while it is a good store of value, it may not be the most convenient form of payment. Stablecoins that gained a lot of popularity, thanks to Tether’s USDT, are now flooding the cryptocurrency market. There are over one hundred different stablecoin projects that exist in the market today with several more still to be launched in the coming year. Cryptocurrencies are gaining traction not only from retail investors, but also from institutional investors, which makes it the most apposite time to discuss their role in mass adoption.
The Rapid Growth of the Stablecoin Market. (Source: Blockdata)
What Makes Stablecoins Stable?
Cryptocurrency trading is not for the faint-hearted. Volatility dominates the cryptocurrency market. In 2017 alone, Bitcoin went from having a value of around $900 at the beginning of January to reaching an all-time high of around $20,000 in mid-December, and then falling to $3,000 by December 2018. This is a general phenomenon prevailing throughout the industry with one exception: Stablecoins. At times of high volatility in the cryptocurrency market, investors have sought refuge in stablecoins. Since they are pegged to real-world assets such as the US Dollar or even gold, investors can simply trade a cryptocurrency for a stablecoin.
Primarily, there are three broad categories under which stablecoins can be classified:
- Asset-backed/ Fiat Collateralised
As the name suggests, the asset-backed or fiat collateralised category includes those stablecoins that are backed by fiat currencies or commodities. Some of the more popular stablecoins that fall under this category are Tether, USD Coin, Gemini and Digix.
- Crypto Collateralised:
Crypto-collateralised stablecoins are backed by crypto and/or multiple assets. MakerDAO and Steem are some of the most notable stablecoins in this category.
- Non-collateralised/ Algorithmic:
The non-collateralised/algorithmic category includes stablecoins that use a smart contract with a shares-for-coins and coins-for-shares system to algorithmically regulate coin supply in order to stabilise coin prices. Examples of non-collateralised/algorithmic stablecoins include Terra, Ampleforth, and Element Zero.
Source: State of Stablecoins Report, Reserve
What Problems are Stablecoins Solving?
- Stability
Even though Bitcoin and other cryptocurrencies have opened up the markets to new opportunities, their volatility does pose a threat to mainstream adoption. The speculative nature of the current cryptocurrency market means that prices will continue to remain volatile until we have a major breakthrough with mass adoption, making stablecoins more important than ever.
Regardless of under which category the stablecoins fall, they are designed to be stable over an extended period of time. This will enable them to become an ideal safe-haven asset during periods of dramatic fluctuations by allowing individuals to store value in the stablecoin. Furthermore, this will also offer reassurance as the trader keeps full custody of the assets.
- Trading
Linked very closely to the stability aspect of stablecoins is the next use case: trading. Even though a number of companies are now creating fiat on-ramps and off-ramps to make buying cryptocurrencies easier, these on-ramps and off-ramps require the payment of fees. This makes stablecoins a prime candidate for anyone trying to reduce their crypto exposure without fully cashing out. Even though Bitcoin has the largest market cap of all cryptos, US dollar-backed stablecoin, Tether (USDT) commands the highest trading volume. Even though stablecoins are supposed to have a stable price, at times of massive volatility, we can see that stablecoin prices also fluctuate. When the market dumps, major stablecoins have seen their prices appreciate mostly because people do not want to completely exit the market. Traders are mostly looking for the right time to re-enter the market and having exposure to stablecoins allows them just that. Today, most, if not all exchanges offer stablecoin pairs since they have gained in popularity among crypto traders.
Binance, one of the world’s largest and most popular cryptocurrency exchanges, published a report earlier this year which showed a growing interest in USD-collateralised stablecoins, in which the 24-hour quote asset volumes driven by stablecoins grew from 35.78% in May 2018 to 60.55% in May 2019.
- Payments
This use case is by far the most promising for cryptocurrencies. Several companies have begun accepting cryptocurrencies, most notably Bitcoin, as a form of payment. However, the big question remains as to whether people are really comfortable paying with cryptocurrencies. Cryptocurrencies, to a large extent, are still being used for speculative trading and their volatility is a huge barrier to encouraging people to use it for payments. Remember Bitcoin Pizza Day? On May 22, 2010, now known as Bitcoin Pizza Day, Laszlo Hanyecz agreed to pay 10,000 Bitcoins for two delivered Papa John’s pizzas. This day has been etched in history because this has become the prime example to illustrate how far Bitcoin has come. Of course, at the time he spent it, the price of Bitcoin was nowhere close to what it is today. But to illustrate the point, not many people would want to become the next Laszlo Hanyecz. Stablecoins offer the same benefits of custodianship and blockchain, without the volatility, making them a good use case for payments.
Several companies are already encouraging the use of stablecoins. Coinbase’s payment arm, Coinbase Commerce is encouraging shoppers to use its stablecoin, USDC. Terra, a Korean stablecoin startup, attracted over 240,000 shoppers in 40 days to pay for items like coffee, clothes and even baby wipes.
- Financial Services
Other prime uses for stablecoins include financial services such as remittance, settlement and escrow. Overseas workers trying to send money back home not only have to pay hefty fees, but also have to wait a considerable time before the money is received by the intended. Stablecoins could play a major role in cross-border payments and remittance due to the simple fact that they don’t require middlemen, hefty service fees or time using the blockchain, all without having to worry about volatility. Settlements take time as they are constrained by banks’ working hours, but blockchain works 24/7.
Institutional Players Getting in on the Action
All of these use cases provide a strong argument for why stablecoins have gained popularity today, which in turn has encouraged several institutional players and some of the largest companies in the world to test out their own stablecoins. One of the largest investment banks in the world, JP Morgan, has launched its own stablecoin known as JPM, which is currently being used internally. This digital token is designed to make instantaneous payments using the blockchain. The JPM coin represents US dollars held in designated accounts at JPMorgan Chase, where the value of each JPM Coin remains equivalent to one US dollar.
Likewise, one of the most debated and controversial projects to be announced in 2019 was a Facebook stablecoin project, called Libra. Whether the Libra project will see the light of day or not is a discussion for another day, but what it represents is the need for stability in the crypto-sphere that may well come as a result of more stablecoins.
Institutions are not the only ones getting into the niche stablecoin market. China has been working on its own digital version of the Chinese Yuan and as reports suggest, this stablecoin, dubbed DCEP (Digital Currency/Electronic Payments), is already being tested by seven entities, including some of the largest banks and companies in China.
Do we Really Need Stablecoins?
Until a decade ago, the cryptocurrencies we know today did not exist, and stablecoins, in particular, did not surface until a few years ago. However, today, cryptocurrencies have become a very important part of financial markets and stablecoins have carved out an important niche for themselves in the cryptocurrency space. Cryptocurrencies started out with no intrinsic value and gained huge popularity and perceived value thanks to raging speculative demand. Stablecoins gained popularity early on as a good hedging instrument for crypto traders. Today, potential use cases for stablecoins are being explored not only by companies, but also by governments around the world. Gradually, several stablecoin use cases have emerged that could potentially act as a gateway to bring more people into the crypto ecosystem.
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