Cryptocurrency is known to be prone to extreme volatility, and as a result, there have been many attempts to try and solve this problem. While a cryptocurrency is fungible, transferable, convenient, tradable, and valuable, it does not have a stable value. Because of this, many stores and firms have been cautious of accepting payments in Bitcoin or other altcoins as price swings aren’t good for day to day business.
Many have considered stablecoins to be the solution to the crypto volatility issue, but on the other side, there are skeptics that believe this leads to market manipulation.
Since the market crashed in January, stablecoins have been making their way up in the list. The most notable stablecoin is Tether, currently ranking 8th in terms of market cap, which has its valued pegged to the US Dollar.
Of course, many other digital coins of this kind have appeared on the market. The question here is if stablecoins will solve the market’s price volatility or generate more problems.
What Do Stablecoins Aim to Resolve?
With cryptocurrencies like Bitcoin and Ethereum continually fluctuate at fast rates, not everyone is thrilled to ride the shifting market waves. This is where stablecoins come in.
Stablecoins are digital assets that were created to keep a relatively constant value in spite of market changes. Such coins are often tied to a fiat currency like the US dollar or collateralized against other real-world resources.
They are a store of value just like money you would keep in a bank account and not an uncertain investment. Depending on their type of backing, there are different types of stablecoins.
Types of Stablecoins
For a cryptocurrency to be considered a stablecoin it has to be backed by an asset (or assets) that represents real value. As such, there are different categories of stablecoins:
These coins are backed up by reserves, meaning their value is tied to the value of the asset stored in reserve. Tether is tied to the value of the USD, but a stablecoin can be backed by any type of asset or currency, like EURS is backed by Euro.
Some stablecoins use cryptocurrency instead of fiat as collateral. For example, Havven uses its native cryptocurrency (HAV) to back up its stablecoin (Nomins).
A stablecoin can be backed by multiple assets. For example, Globcoin and X8currency are tied to a number of fiat currencies. TrueUSD is also a USD-pegged token, but it relies on multiple bank reserves rather than one reserve like Tether. There are also coins like the Petro that claim to be backed gold, oil, gas, and diamond reserves.
What advantages do they offer?
Stablecoins could impact positively certain aspects of the crypto market.
1. Encourages adoption: A coin with a stable value might encourage people to use cryptocurrency in day-to-day transactions. Cryptocurrencies aren’t widely implemented for commercial uses mostly because customers and merchants can’t depend on prices. If a coin shows price stability, maybe more people would be inclined to use it.
2. Use in recurrent payments: Stablecoins could enable long-term agreements and recurrent payments, like paying the rent or a loan. Even though Bitcoin is currently used for direct payments, it is impracticable to be used for monthly or yearly payments.
3. Easy liquidity for traders: Stablecoins could encourage investors more long-term investments in the crypto market. Since fiat currency is usually more stable, crypto investors opt to convert their virtual assets into cash during periods of high volatility so they can maximize their profits. But, exchanging crypto into fiat currency is extremely regulated, slow, and costly. Tether was designed to be a stable store of value that can be easily reinvested in the cryptomarket.
What disadvantages do they pose?
Stablecoins also have some disadvantages:
1. No transparency: The advantage of blockchain technology is that all transactions are open and stored publicly. On the other hand, fiat-backed stablecoins use private reserves that aren’t easy to investigate. Tether continues to put huge amounts of tokens into circulation, making some to doubt whether it actually has enough USD in its reserves to do so.
2. Collateral value loss: With crypto-backed coins, volatility is still a problem. If a reserve of a certain crypto is used to back a stablecoin and its value drops, the stablecoin could also lose all its value. To prevent such thing from happening, reserves must own funds in excess.
3. Market manipulation: Since some stablecoins are designed to ease the trading process, that ability can be taken advantage of. Tether has been accused of wash trading, who pump up the trading volume of various altcoins by exchanging them for Tether and back again. Exchanges and market analysis sites then show incorrect trading data, which disturbs trading by panicking investors.
4. No demand: Even if a stablecoin does have reserve backing, it could just become worthless as it happens to many other coins. Too many stablecoins appear on the market, therefore, they may rapidly come to be overlooked and worthless.
There are many stablecoins being developed at the moment, and it is certain that more are to come. Even though these coins will always have a place in the crypto market, they will not solve the issue of volatility on their own.