Terrible Tuesday saw the bitcoin value fall by USD1000 in one fell swoop, leaving the bitcoin community in turmoil. All because a bitcoin whale decided to trade 25000 bitcoins for personal gain. Such fluctuations are the norm rather than the exception in the highly volatile cryptocurrency marketplace. Stablecoins were introduced as the complete solution to this much-maligned crypto volatility. These coins slowly but surely gained ground and became popular with the risk-averse investors. 2018-2019 saw an increase in its acceptance with Mark Zuckerburg making his intention of launching a stable coin, dubbed as ‘Globalcoin’ quite clear. JP Morgan also launched its own bank stablecoin JPM recently. In fact, the latter half of 2018 alone saw the debut of 3 stablecoins in quick succession-USD coin (USDC), Paxos Standard Token (PAX) and Gemini Dollar (GUSD). The already existing Tether (USDT), DAI stablecoin and True (TUSD) were faced with tough competition. Blockchain.com reported that the total market value of all stablecoins more than doubled over a period of 12 months-up from $1.4 billion at the start of 2018 to $3 billion today. The stablecoin market value share also went up to 2.7% from 1.5% in September 2018. So, what has made stablecoins the Cordon bleu flavour of 2018 and 2019? To find out, it is imperative to understand what makes stablecoins tick.

Stablecoins are digital currencies that are pegged to one or more fiat currencies or exchange tradable commodities or even to other cryptocurrencies to maintain price stability and reduce volatility. Tether, for instance is pegged to the US Dollar So, every USDT is pegged to 1USD. This is also true for other stablecoins like TUSD, GUSD, PAX, JPM et al. This means that an investor can invest in Tether or TUSD or GUSD and be sanguine he will not suffer losses even when the price of the coin tanks. DAI, is however, different in that it is backed by Ether, another digital currency. There are others that are based on the seigniorage model of banks and use smart contracts or algorithms to expand or reduce supply of coins based on supply and demand for the currency, much the way Central banks determine monetary supply by controlling circulation. So, are stablecoins the Holy Grail of stability? Let’s find out.

The stablecoins are designed to maintain a peg ratio of 1:1 with USD but despite good intentions, price divergences rear their ugly head. The price divergence may be on account of several reasons. In a bid to wrest a share of the market pie from other established coins of its ilk, issuers of new stablecoins offer discounts of upto 1 percent if the stablecoins are used prior to their redemption. The peg is thus broken. The last week of April saw several allegations of financial misconduct being levied by the office of the New York Attorney General (NYAG) against Bitfinex and Tether. It was alleged that Cryptoexchange Bitfinex lost $850 million and used funds of affiliated stablecoin operator Tether to secretly cover shortfall so that the peg ratio of 1:1 with USD was irretrievable broken. This not only resulted in regulators eyeing these currencies with suspicion but resulted in loss of trust of investors.

The Tether upheaval saw other contenders rushing in claiming greater stability and guaranteed unbroken pegs. TUSD or Trust token, as it is called, claimed that it holds US dollars backing the stablecoins in bank accounts with multiple trust companies that have signed escrow agreements and so the peg is not likely to be broken. Paxos Standard also staked its claim to safety and stability by claiming that Paxos tokens are regulated by the New York Department of Financial Services. Every time a Paxos token is created, one US dollar is stored in regulated banks in the United States and audited on a regular basis. This is the closest a cryptocurrency can come to a sovereign guarantee.

So, although stablecoins do offer a stable and easy exit from crypto to fiat and are good stores of value that can withstand the sudden and massive fluctuation in the crypto market, they have a downside. They need to build investor trust by offering their collateral for frequent audit and create a transparent ecosystem where the investor is informed about all the goings-on instead of just going ‘dark’ when a heist happens. But by designing cryptocurrencies that fit the traditional financial mould, we are giving control back to centralized third-party intermediaries. This being the case can stablecoins be categorized as cryptocurrencies. In search of stability and ‘a few dollars more’ are we compromising on the basic tenets of cryptocurrencies as propounded by Cypherpunks and Satoshi Nakamoto. A question that begs introspection if not an answer.

Published on LinkedIn