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Why Stablecoins might be the Graal of crypto-assets

Stablecoins are of great value to the crypto world since they solve a major problematic inherent to crypto-assets: volatility. They are a good alternative to fiat for crypto-assets exchange, who face difficulties in accepting payments in fiat due to lack of agreement with banks. We discuss three major designs enabling current stablecoins.

Top 10 stablecoins market cap in million USD as of June 1st, 2019, 5pm

Source: Cryptoslate.com

What is a stablecoin?

A stablecoin can be defined as a crypto-asset purposefully designed stable. Such stability is achieved by pegging them to a relatively stable asset (and thus holding it as collateral), or by being maintained flat by a smart contract-based price control system. To be more explicit, Bitcoin will never fall into the definition of a stablecoin even if it becomes adopted to the point of having fiat-like volatility.

Fiat-collaterized stablecoins

Fiat-collaterized stablecoins are basically tokenized fiat currency, at least in principle. They are issued in exchange of a fix amount of fiat currency per unit of stablecoin. For instance, for $1000 worth of stablecoin issued, $1000 would have to be deposited assuming a 1:1 parity.

Bitfinex’s USDT is the most notorious stablecoin as per its market cap of $3.13 billion. Meaning that, in principle, $3.13 billion are held in reserve somewhere in bank accounts. USDT is built on Omni, a protocol layer built on top of Bitcoin’s blockchain. However, USDT has raised several critics starting with doubts on its dollar reserves. Also, several pumps and dumps of Bitcoin price have proven to be correlated with large amounts of USDT being printed, which might not be a pure coincidence.

Other notable fiat-collaterized stablecoins are Circle’s USDC (USD Coin) with a market cap of $332 million, TrustToken‘s TUSD (True USD) with a market cap of $243 million, and Gemini’s GUSD (Gemini USD) with a market cap of $21.36 million. They are all ERC20 contracts running on Ethereum.

Crypto-collaterized stablecoins

Crypto-backed or crypto-collaterized stablecoins are issued in exchange of a fix amount of another crypto-asset per unit of stablecoin. As a result, they are more complex to manage since the underlying crypto-asset serving as collateral, can be extremely volatile. Consequently, crypto-collaterized stablecoins are often over compensated. For instance, $1000 worth of bitcoin would typicallly be held in reserve in order to issue $500 worth of stablecoin. Hence even in a 40% drop in bitcoin price, the stablecoin would maintain a strong coverage ratio.

Maker’s DAI with a market cap of $243 million is an example of crypto-collaterized stablecoin. It is backed by Ether in its version 1.0.

Crypto-collaterized stablecoins can be seen like artificially stable crypto-assets. They are eventually more costly to maintain. Not only because they require extra amounts in reserve, also because of the opportunity cost of capital of the crypto-assets held in reserve, thus not allowed to be stacked (at least in principle).

Non-collaterized stablecoins

Non-collaterized stablecoin manage to keep a stable value through a price control system based on smart contracts. Basically, in case of an increase in demand for the stablecoin, the smart contract would automatically increase its available supply so as to maintain the target price. Same story in case of a demand decrease.

Non-collaterized stablecoins can be seen as the Graal of crypto-assets. They would typically leverage seigniorage, an algorithmic governance approach to expand or contract the circulating supply. An example of them is CUSD (Carbon USD), launched in September 2018 on Ethereum. Its protocol makes use of supply decreasing by issuing Carbon credit through an auction. Users and token holders can bid for Carbon credits in order to burn CUSD, which offers them a discount as the token expands and helps maintain the price. As the token changes value, Carbon sells tokens to readjust the price.

Despite all the promises from stablecoins, numerous critics exist around stablecoin. Preston Byrne, an attorney well know for writing radical opinions on stable coins, stated that “the techno-magical idea that a cryptocurrency can tell the market what its price should be, rather than the market determining what a cryptocurrency’s price should be”.

Check the full version of Blockchain Quarterly (Q1 2019) report for more Insights.