Tuesday 30 October 2018 10:24 am

Stablecoins – the cryptocurrency pegged to reality – could save the market

Samuel Leach is chief executive of Samuel & Co trading.


The last few years have seen the crypto market experience exponential growth, and at the time of writing, it was worth £152bn globally.

However, predictions that cryptocurrencies will supplant conventional forms of money have so far proved to be unfounded, as their wild volatility makes them unsuitable for day-to-day use by consumers.

But it isn’t necessarily all doom and gloom for digital currencies. The key to their future mainstream adoption may lie in stablecoins.

Stablecoins are a class of cryptocurrencies directly pegged to a “real world” asset, such as the dollar or gold. Around 66 per cent of the stablecoins currently in existence are pegged to the US currency, but with more than 57 different stablecoins undergoing development globally, this figure is sure to change as the market undergoes further fragmentation.

As implied by the name, what distinguishes stablecoins from traditional cryptocurrencies like bitcoin or ethereum is their relatively high levels of price stability.

The speculative nature of most cryptos has led to extreme volatility, with daily price swings of 10-20 per cent not being uncommon. But by endeavouring to maintain price parity with conventional financial assets, stablecoins are insulated from these tumultuous market conditions.

There are three main types of stablecoins in circulation, each using a different method to combat potential price volatility.

The first, fiat-collateralised stablecoins, are similar to how paper money was once pegged to bullion reserves via the gold standard. Stablecoin tokens are issued in direct exchange for fiat currency, so for every token in circulation, there is the exact equivalent amount held in reserve. The price is maintained through confidence that a token can be converted back into fiat at any point.

The second most popular type is cryptocurrency-collateralised stablecoins. This relies upon the value of other cryptocurrencies to maintain a price peg and a system of smart contracts to account for potential fluctuations in value as well.

Finally, algorithmic-based stablecoins use software programs to maintain price parity.

As demand for a token increases, supply of the stablecoin will also increase. In the same way, if demand falls, supply will automatically be constricted to ensure that there isn’t a depreciation in the token’s value.

The market is currently dominated by tether, which accounts for 98 per cent of all stablecoin trading volume.

However, tether has attracted criticism regarding its corporate opacity by failing to independently verify that it has the $2.7bn in reserve that it claims to have, casting serious doubt over whether the token is actually truly pegged.

Tether also shares much of its management team with Bitfinex (one of the world’s largest cryptocurrency exchanges), and a paper released by the University of Texas at Austin’s Department of Finance has claimed that tether was issued to manipulate the price of bitcoin. This lack of transparency has been cited as one of the reasons why tether has supposedly recently lost its peg to the dollar.

The decentralised nature of the crypto market means that regulation is all but non-existent. As such, mainstream financial institutions have remained cautious when it comes to engaging with cryptocurrencies for fear of being non-compliant.

This means that many crypto exchanges are unable to accept direct fiat deposits, and traders face liquidity issues when they attempt to convert their cryptos back into fiat.

This, added to the fact that merchants and consumers are reluctant to make or accept payments in crypto-currencies due to the volatility, makes it unlikely that digital currencies will see mainstream adoption anytime soon.

But stablecoins solve both of these issues. For traders, the inherent nonvolatility of stablecoins means that they can be utilised to safeguard gains made in other forms of cryptos, without going through the arduous process of fiat conversion.

For merchants and consumers, stablecoins provide confidence by giving surety that a customer will not need to time their purchases to get the best price, as well as assurance that a merchant will not see the value of received payments eroded.

The development of stablecoins may also eventually lead to more intricate financial products being built on crypto, like insurance, loans, and savings plans.

In turn, this has the potential to lead to the vast expansion of the global cryptocurrency user-base. But it does remain to be seen whether or not stablecoins will truly live up to their potential.

Without doubt, the concepts that underpin stablecoins are incredibly exciting, and the benefits they could bring may revolutionise the entirety of the global economic system.

Nevertheless, like any new technology, troubleshooting is needed, and problems will be encountered. How the creators and engineers behind stablecoins respond will determine the technology’s future.