stablecoin

A stablecoin is a cryptocurrency where a fixed price, for example in euros or dollars, is guaranteed. At 'normal' cryptocurrencies the price is determined by the open market. The idea behind a stablecoin is that it offers the stability of a "fiat" currency, such as the euro, and at the same time possesses the censorship-resistant properties of a cryptocurrency. These features make a stablecoin attractive to pay with and to store value. A well-known example of a stablecoin is the Tether.

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Why use a stablecoin:

Volatility:
The volatility of cryptocurrencies makes it difficult to use them as money and undermines trust. The fact that cryptocurrency, and the associated technology, is still in its infancy makes it very difficult to accurately determine its value. Because cryptocurrencies are currently so volatile, most are mainly bought by speculators who profit from the fluctuating rates. As an entrepreneur or consumer, you obviously do not have to wait for a means of payment that makes it hard for you to estimate whether it will retain its purchasing power. A cryptocurrency whose value remains more or less the same can therefore be very useful.

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Transport means:
In addition to the utility for consumers and entrepreneurs, a stablecoin is well suited to transport value. In practice, you now see that stablecoins are widely used to exchange value between cryptocurrency exchanges. For example, on one exchange you can purchase the Tether stablecoin with euros, and then transfer the tethers to another exchange. On the other exchange you use the tethers again to purchase other cryptocurrencies. You can also see it as transporting euro value to places that normally do not have access to it, such as small exchanges without a bank account.

Access to stability:
It is often said that people, in countries where the local currency is subject to inflation, can use Bitcoin to escape this inflation. Although that is a good idea in theory, it is difficult to defend in practice if you see that bitcoin loses 65% of its value in eight months. A stablecoin, on the other hand, could give people in these countries access to, for example, the dollar through decentralized cryptocurrency exchanges.

Three types of stablecoins

We currently distinguish three types of stable coins. Each stablecoin uses its own way to maintain stability through a linked collateral.

1. Fiat-backed stable coins.

Link:
The so-called 'fiat-backed' stable coins are supported by a link with a 'fiat' currency such as the dollar. Tether is an example of a fiat-backed stablecoin. The entity 'Tether Limited' says to buy a dollar for each sold tether which they put in a bank account. If you sell a tether, you will in principle get a dollar back.

Bottleneck (s):
Centralization: All fiat-backed stable coins need a central entity to maintain the 1-to-1 ratio. As the owner of the stablecoins, you must therefore trust that this entity will actually ensure that there are enough dollars or euros in a bank account to support the stablecoins or to pay for them again.

Censorship: because a stable coin is managed in practice by one or more managers, there is a chance of censorship of payments. Governments or regulators can force the administrators to block specific transactions to specific individuals. This means that the stablecoin is in fact nothing other than the digital dollar and euro that we already have.

Well-known Fiat-backed stable coins:
Tether
TrueUSD
GEMINI dollar

1. Crypto-backed stablecoins.

The so-called 'crypto-backed' stable coins are supported by other cryptocurrencies. Instead of a 1-to-1 ratio, these are supported by storing a higher ratio of other cryptocurrencies as collateral than that there are stable coins. The collateral can consist of one or more cryptocurrencies. Dai is an example of a crypto-backed stablecoin. For every 100 DAI, 150 ETH are retained as collateral.

Bottleneck (s):
Unforeseen events: because crypto-backed stablecoins are supported by a volatile collateral, they run a risk. An unforeseen event, a so-called 'black-swan' event, could ensure that the collateral, and thus the stablecoin, becomes worthless.

Known crypto-backed stable coins:
Dai (maker)
bitUSD
Havven

1. Algorithm-backed stable coins.

The so-called 'algorithm-backed' stable coils try to keep the value stable through monetary policy. They do this by allowing the amount of coins to grow & shrink and in fact take over the role of a central bank. For example: if the price of a stablecoin is too high, the algorithm of the stablecoins will make new stable coins and put them into circulation. This will be done until the stablecoin has reached the desired price again. If the price of the stablecoin is too low, the algorithm will buy stablecoins on the market. By issuing bonds, holders of the stablecoins are persuaded to convert their stablecoins for these bonds with which the stock of stablecoins in circulation decreases.

Bottleneck (s)
Complexity: the developers behind an algorithm-backed stablecoin have to come up with a way to automatically adjust the amount of coins so that their stablecoin maintains the desired value. Increasing the number of stable coins is relatively easy. However, shrinking the number of stable coins with the use of bonds is much more difficult.

Known algorithm-backed stable coins:
Base
Reserve
Carbon

conclusion

Currently, stable coins are still very experimental and the possible effects of stable coins on the cryptocurrency ecosystem can not yet be fully met. The promise of value stability and censorship resistance is also often not feasible in practice. It remains to be seen whether the promise of stablecoins will actually result in something useful for the long term. The attention for and the impact of stablecoins continues to grow, so we keep an eye on the subject.