What is a stablecoin?
What is it used for?
How are stablecoins created
and are they really a good idea?
Well stick around,
in this episode of Crypto whiteboard Tuesday
we’ll answer these questions and more.
Hi, I’m Nate Martin from 99Bitcoins.com
and welcome to Crypto Whiteboard Tuesday
where we take complex cryptocurrency topics,
break them down
and translate them into plain English.
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Today’s topic is stablecoins.
Most cryptocurrencies were meant to serve
as a medium of exchange
and not just a store of value.
The problem is that
due to their relatively small market cap,
even popular cryptocurrencies like Bitcoin
tend to experience wide fluctuations in price.
the smaller a market cap an asset has,
the more volatile its price will be.
Imagine throwing a rock into a small pond.
Now take the same rock
and throw it into the ocean.
Clearly, the rock will have
much more of an effect on the pond
than on the ocean.
In the same manner,
the cryptocurrency market cap
is a small pond for now,
and is more affected by everyday
buy and sell orders
than, say for example, the US Dollar.
This creates a major issue
since you can’t enjoy
the benefits of cryptocurrencies
which include the decentralization of money
and a “Free for all” payment system,
without the value volatility
that accompanies it.
Imagine how hard it is to use Bitcoin
or any other cryptocurrency
for day to day transactions
and trading purposes
when one day it’s worth X
and the next day it’s worth half of that.
Just think what it feels like to be the guy
who bought 2 pizzas for 10K Bitcoins
8 years ago…
That’s exactly where stablecoins come in.
stablecoins are an attempt to create
a cryptocurrency that isn’t volatile.
A stablecoin’s value is pegged to
a real world currency,
also known as fiat currency.
the Stablecoin known as Tether, or USDT,
is worth 1 US dollar
and is expected to maintain this peg
no matter what.
Stablecoins allow for
the convenience of cryptocurrency,
which means fast settlement
and fewer regulatory hurdles,
along with the stability of fiat currencies.
Like most coins,
the most obvious use case would be to
use them as a medium of exchange
for day to day purchases.
But since these coins aren’t very popular
at the moment,
no one really accepts them
as a payment method.
So the main usage of stablecoins today
is actually on cryptocurrency exchanges.
traders can trade volatile cryptocurrencies
for stable cryptocurrencies
when they want to lower their risk.
For example, if I’m invested in Bitcoin
and I don’t want to risk the price of Bitcoin
falling against the US dollar,
I can just exchange my Bitcoins for USDT
and retain my dollar value.
Once I want to “get back into the game”
and hold Bitcoins,
I can just exchange my USDT back to BTC.
This method is extremely popular
with crypto-only exchanges
that don’t supply their users with the option
to exchange Bitcoin for fiat currencies
due to regulation.
Another great advantage
of stablecoins is that
you can move funds
between exchanges relatively quickly,
since Crypto transactions are faster
and cheaper than fiat transactions.
The option for such a fast settlement
makes arbitraging more convenient
and closes the price gaps that you
usually see between Bitcoin exchanges.
So for now,
stablecoins are more of
a utility coin for traders
than an actual medium of exchange.
But how are they made possible?
What keeps their price from the volatility
that other cryptocurrencies experience?
Well, there are several ways a company
can try and maintain its stablecoin’s peg
to a fiat currency.
The first way to maintain a peg
is by creating trust
that the coin is actually worth
what it is pegged to.
if the market doesn’t believe that
one USDT is really worth one dollar,
people will immediately dump
all of their USDT and the price will crash.
In order to maintain this trust
the company backs its coins
with some sort of asset.
This collateral is basically proof
that the company is good for its word
and that its coins should actually
be worth the pegged amount.
For example, in Tether’s case,
each USDT is said to be backed by an actual
US dollar that Tether holds as collateral.
A different example for collateral
is the DGX token that is said to be
backed by gold.
Another version of
a collateralized stable coin
is one that is backed by
one or more cryptocurrencies.
This form of collateral
is much easier to audit
since a company’s balance
can be viewed on the blockchain.
The second way to maintain a peg
is by manipulating the coin supply
on the market,
also known as an algorithmic peg.
An algorithmic peg means the company
writes a set of rules,
also known as a smart contract,
that increases or decreases
the amount of a stablecoin in circulation
depending on the coin’s price.
Let me explain.
Imagine we have a stablecoin
that is pegged to the US dollar
through an algorithmic peg.
Assuming a lot of people
were to start buying the coin,
its price would rise
and the peg will be broken.
To prevent this from happening
new coins are issued.
This increase in supply alleviates
the price pressure created by the demand
and maintains the coin’s value.
If, on the other hand,
many people start selling the coin,
coins are removed from the overall supply
in order to hold the price peg
to one US dollar.
To be clear,
algorithmically pegged stablecoins
don’t hold any assets as collateral.
The smart contract that manages the coin
acts as a central bank.
It tries to manipulate the price
back to the peg
by changing the money supply.
There are pros and cons
for each pegging method.
Fiat collateralized pegs
transmit the highest degree of certainty
to stablecoin holders
that the coin is indeed worth
the asset it is backed by.
However, fiat collateralized pegs
have some major cons.
For one, from the company’s standpoint,
the asset is frozen
and can’t be used for anything else.
Also, there’s always
the risk of embezzlement
or the closing of
the company’s bank account,
which can ruin the trust in the stablecoin.
Another issue with
fiat collateralized stablecoins is that
it’s hard to actually prove
the company owns enough of the asset
to really back the amount of coins
Tether, for example,
has suffered severe criticism
and audit requests from skeptics
claiming the company
doesn’t have enough collateral
to back the USDT in circulation.
Crypto collateralized coins,
on the other hand,
may have the benefit of viewing
the collateral on the blockchain,
but the collateral itself
is extremely volatile.
That’s why a premium is needed.
In many cases that company will hold
150% or even more
of the collateral needed,
to make up for possible drops
in cryptocurrency prices.
Algorithmic pegging benefits from the fact
that the company doesn’t need to
hold any asset on hand.
However, many will argue that
algorithmic pegging theory
doesn’t really work in real life,
since manipulating the money supply
isn’t a guarantee the peg will hold.
With all of the complexities
in maintaining a stablecoin’s peg,
you might be wondering
what’s the incentive to create a stablecoin
in the first place?
What’s the business model?
Well, for each company
there’s a different incentive.
Some companies can charge a fee
for trading their coin.
Other companies use their stablecoin
as a marketing channel to raise
awareness to the company
and other services it offers.
Houbi, Gemini, Coinbase and Circle
are exchanges that have created
their own stablecoins
in order to attract more users
to their trading platforms
and allow easier transition of funds
within and between exchanges.
Let’s take a moment to go over some examples of
the more popular stablecoins in use today.
USDT or USD Tether,
which I’ve already mentioned,
is a fiat collateralized stablecoin
that is pegged to the US dollar.
The coin was created
by the company Tether
and has remained relatively stable
since its introduction in 2015.
TUSD, not to be confused with USDT,
stands for TrueUSD
and is a relatively new
fiat collateralized stablecoin
that attempts to address
the criticism directed at Tether.
Collateral U.S Dollars
are held in the bank accounts
of multiple trust companies.
These bank accounts
are published every day
and are subject to monthly audits.
GUSD, also known as Gemini USD,
is a fiat collateralized stablecoin issued by
the popular crypto exchange Gemini,
which was established by
the Winklevoss brothers.
According to Gemini,
GUSD is the first regulated stablecoin
in the world.
USDC, which stands for USD Coin,
is a fiat collateralized stablecoin
issued by Circle and Coinbase.
And finally, DAI is a stablecoin
created by MakerDAO
that is crypto collateralized.
There’s a lot of criticism going on
about the creation of stablecoins.
The most common one is related to
the inability of actually maintaining the peg
in the long run.
This could be due to any one of
the reasons I’ve mentioned before.
On top of that,
a quick look at history tells us that
all pegged-currencies are doomed to fail
due to the cost of maintaining them,
especially when that peg
comes under attack.
Some well-known examples
where pegs were broken are
the Swiss Franc peg to the Euro in 2015,
the Chinese Yuan to the US dollar in 2005,
the Thai Bhat peg to the US dollar in 1997
and the most famous of them all,
the gold standard –
pegging the US dollar to gold in 1971.
But the bigger question here is
the issue of governance.
Stablecoins are considered by many
to be centralized
due to the fact that
there is a company behind them
that maintains the peg,
whether it be algorithmic or collateralized.
aren’t really cryptocurrencies
in the sense that they aren’t decentralized.
Another issue is that
stablecoins seem to be providing
a solution to something
that is just a growing pain
and not a constant problem.
Once cryptocurrencies achieve
a higher market cap,
their volatility will reduce dramatically
and there will be
no real use for stablecoins.
Stablecoins are trying to get
the best of both worlds –
the stability of an established currency
with a large market
AND the flexibility of a decentralized,
free for all cryptocurrency.
The problem is that they also get
the worst of both worlds:
A centralized coin with a sort of
central bank controlling it
and a questionable ability to maintain
the public’s trust in it.
Finally there’s the question of regulation –
Will regulators allow companies
to create an asset that mimics legal tender
without any oversight?
One example for such an issue is Basis.
An algorithmically pegged stablecoin
that raised over $130m for its project,
just to shut down due to regulatory issues
not so long ago.
It seems like stablecoins are some sort of
a temporary utility for exchanges,
allowing traders a haven out of volatility,
without needing to supply them
with a regulated fiat option.
In the long run,
it’s hard to be sure how or whether
these coins will have a place
in the crypto ecosystem,
especially with so many question marks
Well, that’s it for today’s episode of
Crypto Whiteboard Tuesday.
Hopefully by now you understand
what Stablecoins are
and how they work –
A type of cryptocurrency that is pegged
to the value of a less volatile asset,
usually the US dollar.
You may still have some questions.
If so, just leave them
in the comment section below.
And if you’re watching this video
and enjoy what you’ve seen,
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Thanks for joining me
here at the Whiteboard.
For 99Bitcoins.com, I’m Nate Martin,
and I’ll see you… in a bit.