Stablecoins: Get Clued Up On the Cryptocurrencies Designed to Overhaul a Volatile Market UnitedCrowd Follow Jun 19, 2019 · 12 min read

Not very long ago, Bitcoin seemed like the ideal economic enterprise for the Everyman to prosper with. Free from the reins of regulation and set aside from policy tied to any one jurisdiction, it’s easy to see why the original cryptocurrency has continued to stir up such interest since its emergence. For many, Bitcoin has certainly proved a lucrative venture, with Bitcoin’s performance putting that of conventional legacy assets to shame. However, despite being around since 2009, the world’s first decentralised cryptocurrency is still a way from being adopted on a mass scale. The reason for this struggle for total take up? Well, it’s largely down to fluctuations in price.

Bitcoin Price Crash Case Studies

For many active in the cryptocurrency sphere, 2017 might have at first seemed like a very exciting year indeed. It was certainly a dynamic twelve months for cryptocurrency in general, with staggering gains that factored into the measure of thousands. However, once the dust had settled, 2018 was quick to cast a dark and gloomy cloud over proceedings. It was a chaotic time to be involved with Bitcoin, that’s for sure. Some celebrated for a time, while plenty found ample time to commiserate. Things were clearly headed for a market bubble and crash scenario, with value rising at breakneck speed and heading into those dizzying factors of thousands.

The more pessimistic commentator has plenty to say against Bitcoin and it’s hard to argue them. For one, there’s no actual proposal for new development or the creation of an innovative solution at the root of the currency. Unlike later cryptocurrencies which carry this kind of thing in their DNA from the off, Bitcoin is merely a decentralised digital currency. Admittedly, it’s a pioneer of cryptocurrency and established much of the framework for what came next, but there’s very little weight to its concept beyond a simple function. Due to its limited nature, Bitcoin has often drawn the ire of negative news agencies and outlets. In the past, it was outright suspicion of cryptocurrency in principle. No regulation and no requirement for intermediaries was flagged with suspicion from the off, while stories of the currency and its use at online black markets stole many a column inch in the early 2010s. Remember all that furore about the Silk Road?

The good intent behind the blockchain and far-reaching applications for cryptocurrencies are nowadays more readily accepted, thankfully. That being said, those journalists from 2011 and 2012 casting shade on all things Bitcoin weren’t without some merit to their argument. Be its key function a medium of exchange, currency or payment system, Bitcoin was always a little limited in its applications. Horror stories in the press were unavoidable when the digital asset was being used erroneously with ease. And even easier to forecast was that the speculative bubble that Bitcoin created was going to burst. Peaks and troughs in the market are to be expected, but the extremes seen during 2017–2018 were a clear indicator something had to give.

There’s certainly negative aspects to cryptocurrency that some can take advantage of or fall victim to, but the raft of advantages are impossible to ignore. However, despite these enticing perks, there’s still a reluctance on the part of many heavy-hitters from joining the game. The casual Everyman simply doesn’t have a mind for investment, let alone the stomach for it. As a general rule, many countries have regulation in place that works to the determinant of cryptocurrency activity. This only serves to make volatility even more of an issue, deterring investors from financial institutions from coming on board in any significant way.

Token Velocity

When users are utilising coins as a currency, rather than holding on to their assets, so-called token velocity is much higher. In short, token velocity simply refers to the amount of times a token changes hands in a given stretch of time. Perhaps you’re one of those contributing to lofty token velocity figures, or perhaps you’re someone who prefers to hold onto their crypto tokens, content with them collecting digital dust on a hardware wallet. Being someone who follows a HODL philosophy is nothing to be coy about. In fact, a Hold On for Dear Life approach to crypto is more likely to earn you a nod of respect than anything else. Why? Those who hold tend to have their mind patiently focused on the long-term, keen to see plans and visions come to fruition, while avoiding the urge to flip their currency. It’s not just patience that puts so-called HODLERS in such good standing, either. Keeping hold of a significant amount of cryptocurrency can be an incredibly stressful experience when market value starts to swing into extreme territory.

Volatility Solved: Stablecoins

Stablecoins provide a nifty way of tackling the issue of volatility in the crypto market due to the fact they’re pegged to a real world assets with a fixed value. Generally speaking, this fixed value is represented by fiat currency assets or commodities. What’s more, stablecoins also offer the base functionalities of money, such as serving as a means of exchange and a unit of account. And let’s not forget that key function of value storage.

When it comes to executing cryptocurrency transactions, things have been made more difficult thanks to a fluctuating market. One claim of stablecoins is that they will help put an end to such complications. In particular, stablecoins aim to overcome the issue of it being nigh on impossible to be able to make a transaction for a specific crypto amount. A chief objective for stablecoins is to maintain the value of a transaction, ensuring it remains unchanged from A to B. With this solution in mind, we can now look to cryptocurrencies as a more serious method of long-term storage of digital assets with an eye toward profiting from maturation of value.

Centralized and Decentralized Stablecoins

When it comes to stablecoins, you can generally divide them into two schools of thought and approach: centralized and decentralized.

Let’s look at centralized stablecoins first. In these cases, there’s always a centralized entity in the mix that maintains oversight and possession of involved assets. When it comes to decentralized stablecoins, there’s almost always a smart contract in place that serves to stabilize associated value.

Centralized Stablecoins Explained

These types of stablecoins are issued via a financial institute that has been granted custody of the respective backing assets. When it comes to assets that can be deemed collateral, there are two key types to consider when stablecoin is issued. These are conventional fiat currency and commodities.

Fiat-backed is the most frequently seen coin type, where stablecoin is implemented by issuing it against regular fiat currency with the aid of a centralised financial entity. Flat-backed stablecoins have several key features that defined them, with some of the most important outlined below.

For starters, value itself is pegged to a fiat currency such as Pounds Sterling or US Dollars, with a fixed ratio in place. As an example, a single stablecoin token would therefore be equal to a single British Pound or US Dollar. Stablecoin and USD combinations are the most commonly seen pairings, but other combos of currency can be used. As for the fiat currency being used to back the coin, well that firmly remains in the possession of associated financial institutions.

Transactions and Trust

As far as transactions are concerned, these are free to operate off-chain, or over a designated private or public chain. Overall collateral also needs to equal the total circulating supply of stablecoins at any one time. Looked at from a technical standpoint, this keeps things simple. Institutions simply issues stablecoins based upon the total they are in possession of. These coins can be traded on exchanges and can also be redeemed if the relevant financial institution is issued.

A massive part of the stablecoin philosophy is trust. There needs to be great levels of it in what’s backing it. Delve into the details and it’s easier than you think to feel at some ease with financial institutions being involved. There’s indeed incentive to increase the amount of fiat that’s backing stablecoin, thanks to risk-free interest accumulation. There’s also far lower associated costs for financial institutions involved.

Backed by Commodities

These are stablecoins where the value has been pegged to commodities that have been used for backing. Obvious candidates for commodities include gold and silver, although other previous metals and crude oil are increasingly popular choices.

Value is then pegged to asset at a fixed ratio. As with fiat backing, any commodities remain in the possession of financial institutions backing the respective coin at any given time.

Also as before, transactions may occur off-chain, or over a private or public chain. Additionally, overall collateral needs to be a match for the total supply in current circulation. One thing to note here is that a president for price fluctuations of assets involved will require some financial insights and keen management attention. Also, there’s usually higher costs involved for commodities, with things like storage often racking up fees.

Any commodities represented by stablecoins must be free to trade on exchanges, while also being redeemable via issuing financial institutions. Once more, trust is hugely important. A larger deposit can often boost the books, which has a positive subsequent effect on financial institute leverage.

Decentralized Stablecoins Explained

In the case of decentralized coins, things aren’t governed by a single, controlling entity. Instead, control is assumed by code which serves to have a stabilising affect on coin value. However, additional entities do need to participate here, with these third parties helping ensure that stability is achieved and maintained.

Backed by Cryptocurrency

In most instances, a decentralized stable coin will have the backing of cryptocurrency behind it. There’s no discernible difference between backing from cryptographic or conventional fiat currency here, although it’s worth noting that smart contracts are implemented due to the specifics of such transactions and the entire thing happening on the chain. Coin users rely on their own funding as a means of a collateral, with this usually standing as a higher overall amount than any stable coin allocated to compensate should a sudden crash occur. Although the loan to value ratio is higher, the prospect of liquidation events can’t be ruled out. Should such an event occur, there would be a significant domino effect on price.

Some Key Signatures of Stablecoins

For a start, no one central authority assumes control over stable coin collateral. Instead, this collateral is bolted down thanks to innovative smart contract technology, with execution taking place on the chain itself. Another hallmark are the assets these tokens are tied to to help minimise volatility and protect value. In the case of stablecoins, value is pegged to altogether more reliable fiat assets.

To help ensure stable coin prices remain stable, several additional instruments are in place. These include cryptographic oracles, with these systems providing exhaustive information on systems that would not ordinarily be available. Specifically, these cryptographic oracles hunt out liquidations, seeking to make modest profits whenever possible.

Ultimately, these stablecoins are largely alike to their centralised siblings when it comes to many of the fundamentals. However, one noticeable difference is the more significant rate of risk involved. With decentralized stablecoins, there’s a noteworthy risk factor in code exploitation. Should criminal third parties succeed in their code exploiting efforts, system-wide collapse is the consequence.

Admittedly, there’s constant diligence to ensure such breaches don’t occur, but we’ve seen time and again that devastating hacks can indeed happen. When it comes to decentralised stablecoins and their role in the cryptographic ecosystem, there’s a huge amount at stake. Just consider the role of smart contracts in transactions. These smart contracts cannot autonomously execute, requiring a third party to participate in order for it to do so. Should said third party not be able to fulfil their role in the transaction in time, crucial actions might not be realised in the required time frame. As a result, value is pulverised.

Seigniorage (or algorithmic) Stablecoins

These are similar in nature to a Decentralized Autonomous Organization (DAO). This is what maintains control over things like issuance, as well as pricing. These seigniorage/algorithmic stablecoins don’t have any ties to real world collateral and aren’t dependent on it, as well as being wholly digitized of course.

As the code is what’s responsible for supply and demand, as well as ideal target price, this is one corner of the cryptographic realm that’s most definitely decentralized, with no regulatory bodies maintaining watch over proceedings. With both of these benefits bolstering it from the foundations, stablecoins offer a truly scalable solution not currently offered out on the market. What’s more, there’s no need to procure more collateral as supply sees an increase, which is another desirable feature not offered by any counterpart coins that come even remotely close in terms of functionality.

Let’s take stop for a moment to take stock of those key selling features of stablecoins. They are fully decentralized, rather than just boasting claims about it. They are also very scalable, making them a very realistic solution. What’s more, stablecoin transactions are executed on the chain.

Stablecoins hold basic supply and demand philosophy close to their centre. With this kind of cryptocurrency, it’s a lot more affordable to ensure prices stay fixed and immutable. Without any collateral called for, the supply and demand ethos is put into play efficiently, with coins being issued if demand warrants it. If demand drops, then coins are destroyed to protect price immutability and minimise volatile effects. If a price decrease is noted, solutions such as the issuance of bonds can be used. Should prices climb, seigniorage (or asymmetric) shares can be created. This particular type of stablecoin might sound too good to be true, but it’s a very real prospect that’s close on the horizon.

Some Stablecoin Concerns to Consider

They might sound like a holy grail in the world of cryptocurrency, but stablecoins aren’t without potential drawbacks. Let’s start with a simple enough summary about stablecoins and stability. Despite the best intentions and most rigorous development phases, there has yet to emerge a stablecoin that’s been wholly successful in maintaining a specific peg amount for a long period of time. Many a time, when it has come to trade stablecoins, the tokens have traded a little higher or a little lower than their genuine value, in the margins of multiple percent. Still, this isn’t exactly news that would terrify a keen crypto investor. In fact, such performance is encouraging. However, past performance of stablecoins has ultimately proven that they’re not immune to fluctuations in the market.

Seeing Such Coins as a Stabilising Influence

Generally speaking, price movements in the overall market are easy to follow, with Bitcoin’s established connections with multiple coins usually showing minimal drift in behaviour between the two. For the most part, things are largely predictable and correlated. However, with stablecoins comes the prospect to add a whole new layer to the market. As it stands, the market can become very unstable when individuals bring in conventional fiat currency and opt for long or short positions. Stablecoins shouldn’t be seen as a messiah-type entity that will bring serenity and stability to the market, but rather something that can be used by the individual to keen values staple specific to respective coins.

Potential Problems Regarding Vulnerability

With a bold and brand new concept, long-term testing is a luxury that isn’t always a standard. There’s the very real possibility, for example, one such concept proves utterly untenable and comes crashing down, taking the market with it. Such instances have happened before, even if these were on a more minor scale. Don’t think decentralized coins are safe from the prospect of hacks, either. Allowing for a trusted third party to facilitate the central part of an exchange is a staple part of the picture. If this link in the chain becomes compromised, the potential of stablecoins would suddenly look a lot more second-rate in the eyes of many.

What’s Next for Stablecoins?

If you were to asked today to define cryptocurrency by a key selling feature, so to speak, decentralization would still be the go-to bit of vocabulary. However, as more time goes on and the cryptographic ecosystem develops, it’s becoming increasingly apparent that when it comes to realizing those decentralization dreams, we’re still a long way off from pitch perfect. However, while pitch perfect results aren’t the standard, things are coming along nicely and considerable progress has been made in the right direction.

With dozens of individual organisations hard at work behind the scenes to produce innovative solutions, stablecoins are increasingly prolific and entering the more everyday crypto consciousness. stablecoins aren’t just a welcome addition to the party, either. In the cryptographic sphere, they’re an essential cog in a larger machine that needs to be refined and perfected. While volatile trends in the cryptocurrency market might discourage everyday individuals from engaging, stablecoins present an attractive method of diffusing uncertainty and reluctance in individuals, triggering active engagement and, ultimately, benefiting the cryptographic landscape as a whole.

A New Era in Cryptocurrency is Coming

The problem is that no one solution available today is wholly reliable. As such, utilising any of these solutions requires serious forethought and due diligence. As it stands, it falls to the smaller start-ups to pioneer work on those all important solutions, but it’s almost a certainty that larger financial entities will soon engage with the issue. It’s also worth considering that many a start-up is a breeding ground of dynamic development teams and keen talent with an eye for bold new ideas. In short, they’re fertile grounds for those innovative thinkers and big ideas that may define the next era of cryptocurrency and help steer its evolution.

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