One of the largest barriers to mass adoption of digital assets is their tendency to fluctuate wildly in price. The volatility represents an inherent risk to those wishing to transact or store digital assets. The benefits of digital assets are quite clear. Cryptographic payment networks, that can easily traverse international borders offer many attractive solutions.
However, until a few years ago digital assets could not provide the price stability of the world’s leading fiat currencies such as the U.S dollar. Stablecoins are an attempt to combine the best of both fiat and digital assets into one token and as such the market has grown to over $3 billion U.S dollars. Various methods are employed to achieve price stability and are effective to varying degrees. In this two part series we are going to look at some of the interesting methods used to ensure price stability of different categories of stablecoins.
Fiat Backed Stablecoins — value pegged to fiat currency
Tether was created back in November 2014 and each token is backed at a 1:1 ratio with actual U.S dollars stored in a bank. Tether is the only digital asset to make it into the top 10 by market cap, with approximately $2 billion worth of tokens in circulating supply. Tether has in the past traded significantly above and below the price of $1 per coin. When the validity of their deposits were called into question, about the same time as the new regulated stablecoins launched, Tether traded as low as $0.90. When markets have panicked Tether has traded as high as $1.34 as users flood towards perceived stable stores of value. This has made the most popular stablecoin also one with the most price variance. In general however, Tether rarely trades outside of a 5% band of its official $1 per coin. Due to the centralised nature of Tethers bank deposits there exists a single point of failure for the currency. As such digital asset crypto enthusiasts have explored many different methods of obtaining price stability. Tether remains the most prolific stablecoin in the market with almost two thirds of the stablecoin market cap.
Tether is not the only stablecoin to be backed by the dollar. TUSD, PAX, GUSD and USDC are recent entries into the stablecoin market and have seen their market cap increase significantly over the last six months. Gemini and Paxos have both received NYDFS charters and Circle has obtained the “BitLicense”. These new dollar backed stablecoins have so far proven themselves to be much more stable than Tether and have a higher degree of transparency.
Stablecoins do not need to be pegged to the U.S dollar. They can be linked to any currency, commodity or asset (either physical or digital). Through these various currency backed stablecoins, some exciting opportunities have arisen to reduce the costs of currency exchange and disintermediate the process of foreign exchange.