The volatility associated with Bitcoin and other digital currencies is one of the biggest barriers facing the widespread adoption of cryptocurrencies today.
While volatility allows traders to greatly profit when the opportunity is ripe, consumers and organizations that wish to implement cryptocurrencies are unable to do so due to the constant price fluctuations.
In an attempt to address the volatility associated with cryptocurrencies, "stable coins" -- now totaling a market cap in the hundreds of billions -- have entered the crypto market. A stable coin is a cryptocurrency that is pegged to the value of an underlying asset, such as fiat currencies like the U.S. dollar, or financial assets like real estate. This ensures that the value of a stable coin remains consistent, differentiating itself from other volatile cryptocurrencies like Bitcoin.
For example, the Silicon Valley-based startup, TrustToken, created TrueUSD as a U.S. dollar-backed stable coin built on the Ethereum blockchain. Each TrueUSD stable coin is fully collateralized by one USD, allowing it to maintain a constant price of $1, which is held in a professional trust company's escrow account.
TrustToken's smart contracts mint TrueUSD when U.S. dollars clear the escrow accounts, and burns TrueUSD when U.S. dollars are redeemed. This ensures a 1:1 parity between the TrueUSD in circulation and U.S. dollars in the escrow accounts.
Should We Use Stable Coins?
Unlike traditional volatile cryptocurrencies that are ideal for trading and price arbitrage, the use cases for stable coins focus more on developing markets, e-commerce payments and other areas in which cryptocurrencies can be applied for mainstream use.
While these coins can also serve as a low-volatility crypto asset for traders, the primary appeal behind stable coins is that they remain stable, making them the ideal cryptocurrency to use for financial transactions.
"Stable coins serve as a payment mechanism when there is no apparent payment infrastructure already in place. I would go as far to say that stable coins have no investment value, as this cryptocurrency is entirely a tool for a payment mechanism," Dr. Michael Yuan, Chief Scientist at CyberMiles, a company that provides smart contract templates, told me.
While some traders find that stable coins can provide a store of value, many crypto enthusiasts, like Dr. Yuan, see real potential in the ability for stable coins to break payment barriers.
For example, Basis -- formerly known as Basecoin -- is creating a stable coin valued against the U.S. dollar. Basis is doing this by using algorithms to adjust the supply of Basis coins over time to maintain a peg to the dollar. The approach Basis takes is similar to how central banks expand and contract monetary supply by buying and selling fiscal debt to stabilize purchasing power. This is why Basis refers to its system as "an algorithmic central bank."
"Basis is different from other stable coins in that it's an algorithmic centralized bank," says Mayra Ceja, an investor in Basis and Director of ICOs and Equity at crowdfunding platform, Indiegogo. "This is important because it takes a new and different approach from other stable coins on the market. The algorithm-mathematical model allows for a truly decentralized model that automatically expands and contracts the supply of the coins."
The Basis whitepaper describes the use case for stable coins in developing markets, nothing that people living in the United States or Europe, with access to fiat currencies, might not understand why there is a need for a price-stable cryptocurrency. However, stable coins can greatly impact those living in developing nations with unstable currencies.
Countries such as Egypt, Argentina and Nigeria typically experience high inflation rates, causing people living in these nations to be drawn to the U.S. dollar, a process known in financial circles as "dollarization." However, there are significant costs and risks associated with physically importing U.S. dollars across country borders. While dollarization can help reduce inflation, there are drawbacks for emerging markets such as the impact of new monetary policies being made by the Federal Reserve.
Stable coin proponents claim they can solve these problems. As stated in the Basis whitepaper, "a cryptocurrency solution, by which millions of dollars could be transported on one's phone, seems like a vastly superior alternative to paper dollars in all dollarization scenarios."
Additionally, stable coins also can be used by merchants and consumers for e-commerce payments. Price stability is a key requirement for cryptocurrencies to go mainstream and stable coins could provide just that.
As a result, stable coins could very well become an excellent medium used by retailers and consumers for daily transactions. Moreover, stable coins can serve as a cryptocurrency usable for salaries, loans, futures contracts and more.
"The question, 'Can we use cryptocurrency for ecommerce?,' is gaining traction, yet the answer is always no, unless we are using a stable coin," Dr. Yuan said.
While stable coins are likely in the very early stages of development, the blockchain economy continues to advance in parallel with claims of fraud and ensuing regulatory scrutiny. While stable coins lack insulation from fraud and already appear targeted by Securities and Exchange Commission and Commodities and Futures Trading Commission regulators, a price-stable medium of exchange could help cryptocurrencies scale beyond their current state.
While stable coins present opportunities for daily transactions, they remain vulnerable to scams that mis-price coin offerings, and could also be subject to manipulation by insiders or traders holding large volumes that can move coin prices up or down to yield a profit at retail users' expense.
Tether, the best-known stable coin and one that's backed by U.S. dollars and Euros, intended to stabilize cryptocurrency prices but instead drew scrutiny from the investor community that claimed it was a way to manipulate Bitcoin's market price. And questions continue to arise about whether a stable coin like Tether could simply issue volumes of coins without actually having the U.S. dollar, Euro or other fiat currency reserves to support the stable coin issuances.
"Stable crypto coins are very new," Dr. Yuan concluded. "Just imagine Facebook in 2004 or Bitcoin in 2009 -- it will take years before a nascent technology can gain mainstream acceptance. But, like technology innovations before it, stable coins have the potential to change society as we know it."
The author holds stock in investment holding company, Leucadia, and remains a partner in an emerging technology fund. He holds no positions in cryptocurrencies or in any companies that invest in them.