Rehashed - #16 The Rise of the Stablecoin

The Volatility Problem

Although Bitcoin volatility has taken a tumble for the past couple of months, it still remains extremely high relative to traditional asset classes. Due to Bitcoin’s properties, namely its fixed supply of 21 million coins, high volatility is likely to stick around. This is because with a fixed supply, changes in price will be purely at the hands of changes in demand. Because this is largely a speculative market on the future adoption of cryptocurrencies, demand constantly fluctuates around market news and project developments, making high volatility inevitable. This is an issue, as when the price is constantly fluctuating, Bitcoin’s monetary properties as a unit of account, a store of value, and a medium of exchange are far less effective. Bitcoin cannot be a reliable medium of exchange, let alone store of value, if its price is fluctuating 10% on a normal day.

Enter Stablecoins

The introduction of stablecoins is an attempt to address high volatility across cryptocurrencies. Stablecoins are price-stable cryptocurrencies, where the market price is pegged to another stable asset, like the NZ Dollar. They aim to encompass the advantageous properties of cryptocurrencies (censorship-resistant electronic transactions) without the difficulties of a volatile exchange rate. The concept of stablecoins has garnered a mixed reaction across the crypto community, receiving backlash from those who assert cryptocurrencies were meant to replace fiat currency, not co-exist with it. Nevertheless, this year, we have seen a flood of stablecoin designs underway, with much excitement and venture capital money attached.

There are three broad approaches to stablecoin design: fiat-collateralised, crypto-collateralised and non-collateralised. Fiat-collateralised simply means that tokens are backed up by cash in a bank account. Tether (USDT) is considered a stablecoin as it is pegged to the US dollar, however as the pool of collateral is largely controlled by one entity (Bitfinex), the system is highly centralized. Tether is primarily used on cryptocurrency exchanges to offer the low volatility of the dollar to both exchanges and users.

Instead of fiat currency, crypto-collateralised stablecoins are backed by a cryptoasset. The most well-known stablecoin in this category is the Maker protocol, where its stablecoin, Dai, is collateralised by Ethereum. Borrowers create Dai by locking up collateral in an Ethereum smart contract (CDP- collateralized debt position) at a pre-specified, fixed collateralization ratio. When Dai is worth over $1, Ethereum holders are incentivized to create more Dai and sell it, as they make money. When Dai is worth less than $1, CDP owners can pay down their debt at a cheaper price. This is how the stablecoin retains its stability. There is currently (USD) $21 million worth of Ethereum locked in CDPs and (USD) $6.5 million worth of Dai issued.

Non-collateralised stablecoins operate like an algorithmic central bank. The key difference is that the issuer is decentralized and distributed; the stakeholders are the wider public. This concept is not a new one and was first introduced by Friedrich Hayek in the 70s. In Denationalization of Money, he argued that price level stability can be achieved only by removing from national governments their monopoly of money creation. The result would be competitive private currencies that would permit the market alone to choose the dominant currency. Frontrunners in this category include Basis and Carbon, stablecoins that hope to be launched by the end of this year.

List of stablecoins by category

Investing in Stablecoins

What is the appeal to investing in a system that is rooted upon a price-stable asset? Many stablecoins have some sort of associated ‘parent’ token, which yield cash flows from stabilization of the system. For example, Maker is the governing token of the Dai stablecoin. Holders of Maker tokens earn stability fees (interest) from the borrower of Dai in return for helping to keep Dai stable (meaning they act as the final backstop for all collateralised debt positions). Operating in a similar fashion is Australian-founded stablecoin Havven, which has recently launched on Ethereum main net with nearly $1 million in circulation. As with Maker/Dai, in return for stabilisation of the network (by locking value in smart contracts), Havven token holders receive fees. Investing in stablecoins has not escaped the interest of ‘smart money’ Venture Capitalists; earlier this year, Basis raised (USD) $133 million in seed funding.

Most stablecoins are in the very early stages of technical development and economic design. A major concern is that current stablecoin designs operate under the assumption that there will always be a buyer at an arbitrary price. If there is no demand, the system will fail. Furthermore, there is added risk with non-collateralised stablecoins, which are not actually “backed” by anything other than the expectation that they will retain a certain value.

Because stablecoins have had a limited lifetime thus far and there remain many technical and economic design obstacles, it is difficult to evaluate future utility. It's exciting to see volatility reducing mechanisms that may help us realize utility in the crypto space, although the viability of stablecoin design remains a huge question mark.

 

In the News

India continues to prohibit cryptocurrency-related dealings, while many nations such as Abu Dhabi and South Korea are creating rules to allow more secure crypto trading.

Crypto exchange hacks have been rising: year-to-date, (USD) $761 million has been stolen from crypto exchanges, compared with (USD) $266 million for the whole of 2017.

Mining kingpin, Bitmain, has just closed a funding round that values the company at (USD) $12 billion.

Chris Dixon chats about the launch of Andreessen Horowitz’s $300 million crypto fund he is leading.

Switzerland's principal stock exchange has announced that it is developing a blockchain-based platform to tokenize traditional securities.

Institutional custodial products continue to hit the market; Coinbase is the latest to launch, accepting minimum deposits of (USD) $10 million.

 

Upcoming Dates

27 July - Blockchain Forum Auckland

 

As always, thanks for joining - see you next week for Rehashed.

Freddie Archibald

 

View previous issue: Rehashed #15 Declining Bitcoin Volatility and Dispelling Money Laundering Notions

View the next issue: Rehashed #17 Value Capture within the Web 3.0 Stack


About the author:

Capital markets to crypto convert. From Christchurch →  Boston → New York, Freddie became intrigued by the potential of the digital asset economy after plucking a book on Bitcoin off a New York library bookshelf in 2016. Her parents are thrilled that she is chasing magic money on the internet.

 

Disclaimer:  The above references an opinion and is for informational purposes only. The opinions expressed by the author do not represent the opinion of BitPrime.

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