The only thing that’s predictable about the cryptocurrency market is its unpredictability. The volatility may be exhilarating or terrifying for speculators, but for cryptocurrency to become a mainstream form of exchange, observers say, it will have to become more stable.
“Imagine you’re paid a salary of one bitcoin () per month,” Nader Al-Naji, founder of the cryptocurrency, whose parent company garnered more than $130 million in funding in April. “If the price of bitcoin drops, you might not be able to make rent. If it rises, your employer won’t be able to afford your salary. It’s simply not a reliable means of payment.”
Enter “stablecoins,” cryptocurrencies designed to hold a constant value against a stable asset, such as a fiat currency. These currencies’ backers argue that would eliminate volatility while retaining the benefits of cryptocurrency, including global reach and a decentralized store of value.
If stablecoins do go mainstream, we may at long last be able to use cryptos to buy a cup of coffee.
“Now you can pay a salary, take out a loan, or buy coffee with a cryptocurrency, enabling a new economy of cryptocurrency financial applications,” , which launched the trueUSD stablecoin in March and anticipates launching stablecoins tied to the euro and bonds.
Interested? Then here are six things to know about stablecoins:
1. Models and Mechanisms Vary
Essentially, there are three basic models of stablecoins, each of which works in different ways.
Fiat-backed stablecoins, such as (USDT) and trueUSD, are essentially pegged to a fiat currency and the (at least implicit) idea that there’s some amount of that currency tucked away in a bank somewhere that could be exchanged for a predictable amount of the crytpocurrency. As such, audits and other assurances of collateral are critical.
Crypto-collateralized stablecoins, such as , are backed by another, more volatile cryptocurrency (In dai’s case, it’s ether (ETH). Even so, they maintain a stable value against fiat currencies through complex mechanisms that involve overcollateralizing the more volatile cryptocurrency and changing incentives when their value shifts. ( provides an explanation of how this works in dai.)
Non-collateralized stablecoins loosely mimic central banks by controlling the supply of the currency to keep their value stable. Basis, for example, uses the destructibility of tokens on the blockchain to maintain value by “destroying” coins exchanged for bonds when oversupply pushes the value too low and cashing those bonds in when too few coins in circulation push the value above the peg, calling the process “an algorithmic central bank.”
2. Stablecoins Have Real-World Uses Now
Developers see investors using stablecoins as hedges against the volatility of other cryptocurrencies in trading, as they provide an alternative to shifting funds to fiat currencies. In other words, investors could trade bitcoin for stablecoins instead of U.S. dollars or another traditional store of value when bitcoin begins to encounter wide price swings. Then, when bitcoin’s price stabilizes, they could move back into it. “Short-term stability is important for transactions, and long-term stability is important for holding,” writes Sherman Lee, a partner in Zeroth.ai.
3. A Dollar May Not Be Exactly a Dollar
Trading charts for stablecoins show their value does fluctuate. Their backers say that’s a feature, not a bug, however. The ability to exchange stablecoins for fiat currency means traders have a built-in incentive to buy or sell when the price fluctuates, providing yet another mechanism that ensures stability. “Price deviations between trueUSD and the dollar present an opportunity for arbitrageurs,” TrustToken’s founders say.
Dai, which launched in December, points to its stability given the wild price swings in other cryptocurrencies over the past few months as proof its model works. “A true trial by fire,” David Utrobin, a voter in the MakerDAO ecosystem, which created dai.
4. As With Everything, Caveat Emptor
There are questions about the extent to which fiat-based stablecoins are collateralized. Tether drew attention in January when it was disclosed the U.S. Commodity Futures Trading Commission to the company and its currency exchange venue.
As with fiat currencies, there’s also concern about deliberate attempts to distort a stablecoin’s value (known colloquially as a “Soros attack” after financier George Soros’ infamous early-1990s trade in which he sold short the British pound). Basis has a about why its system design would resist such an attack, but others have questioned whether any cryptocurrency can sustain extreme pressures on its value.
5. Scale Will Ultimately Matter
As is the case with fiat currency, the usage of stablecoins is a predictor of their ability to hold value. “The more that basis grows, the stronger its status as a potential medium of exchange, and the stronger its stable equilibrium,” the company’s founders . “At a high level, if basis is successful in getting a foothold as a medium of exchange, its network effect can help keep its value stable even without any physical backing.”
Although the dollar remains a strong store of value due to the same kind of network effect, crypto–collateralized currencies may have to diversify. “If ether’s price falls quickly enough, there wouldn’t be any valuable collateral to support the dai-$1 peg,” Utrobin writes. “However, if you give dai more than one leg to stand on, the risk of insolvency during a black swan event drastically decreases.”
6. Stablecoin May Be Bigger Than Cryptocurrency
In the developing world, where local currencies fluctuate wildly and run the risk of devaluation, stablecoins provide an alternative store of value that could fulfill one of the original goals of cryptocurrency. “Bitcoin was intended to be the solution to these problems,” Al-Naji writes. “But its volatility makes it as deficient and ineffective as a hyperinflating local currency.”
If stablecoins do go mainstream, we may at long last be able to use cryptos to buy a cup of coffee. But their backers argue there’s a greater benefit.
“The adoption of stablecoins will be a catalyst to the new, decentralized internet becoming mainstream,” Lee writes.