Following the invention of Bitcoin and its growing use around the globe, one of the greatest criticisms of cryptocurrencies has been — and continues to be — their volatility. As the technology has been evolving, new kinds of tokens have appeared as well as proposed solutions for holding crypto wealth in a non-volatile token. The main focus so far lies on the ability to store crypto wealth in USD, but some technologies are already available for EUR, CNY, RUB, and many other fiat currencies.

If I had to approach this topic in chronological order, I would mention the first projects that promoted the tokenization of fiat currencies, such as Counterparty, Ripple, or BitShares. Each of these solutions offer a different technological background and philosophy.

Ripple creates IOU tokens that represent debt, Counterparty proposes to tokenize a currency that sits in a bank account, and BitShares puts forward a token that represents fiat currency, collateralized by the BitShares token.

Counterparty and BitShares demonstrate two ways of creating a token, which is pegged one-to-one to USD, using radically different mechanisms. The USD token can be backed by a cryptocurrency or bank account.

1. Cryptocurrency-backed stable coins

In this method, a smart contract creates a token whose value equals 1 FIAT, where FIAT means USD, EUR or any other fiat currency. This is typically collateralized by a cryptocurrency, such that the equivalent of 2 FIAT are locked in the respective COIN.

This is a smart solution that requires a number of mechanisms to renew the locked amount in COIN, in order to maintain a decent collateral amount in the smart contract with respect to the volatility of the COIN. It also requires knowledge of the exchange rate (COIN/FIAT) and an incentive to lock a suitable amount in a smart contract. Several solutions are possible for achieving this, some of which are described below.

1.1 BitShares USD

BitShares is a decentralized exchange platform that uses BTS as the base token of the blockchain. Besides operating as a fully decentralized currency market, the platform enables lending and margin positions on the market. This provides an incentive mechanism for users to lock in funds. It uses the locked amounts of tokens in the market to issue bitUSD, bitEUR, bitCNY, and so on. It works for any fiat currency, so long as the BTS/FIAT market has sufficient volume.

1.2 Ethereum smart contracts

Using a smart contract on Ethereum provides multiple ways to develop mechanisms for creating a collateralized fiat token. MakerDAO and Havven created such tokens with various ways to keep a sufficient amount of collateral and provide an incentive to lock tokens in a smart contract for a period of time.

These smart contracts require the actors of the system to frequently take action on the blockchain in order to optimize the amount of collateral. There are not currently any user-friendly or non-time-consuming mechanisms available to maintain these positions and really use the system to its full potential.

One of the major criticisms of this kind of token is the reliability of the collateral as well as the question of how to make sure that the amount locked against one theoretical fiat token is actually more than the value of the fiat token.

2. Bank account-backed stable coins

Another way of tokenizing fiat currencies simply consists of having a bank account with real fiat currency held by a bank. In this case, the crypto-token issuer needs to keep track of the amount of tokens that have been issued and ensure that there is a one-to-one ratio between the token supply and the amount stored in the bank account.

2.1 USD Tether

Tether uses the Omni Layer to create its token. It took advantage of the Bitfinex network to rapidly gain global visibility. Some criticism has been raised with respect to its regulatory compliance and transparency. It benefits from its first mover advantage and its ties to a very well-known exchange platform in the cryptocurrency space.

2.2 TrueUSD

TrueUSD is an open-source smart contract on the Ethereum blockchain and is implemented to be able to fully comply with US regulation, which is highly restrictive. It is available for clients with large amounts of funds, and they will reduce the threshold in order to be qualified as a TUSD holder. It is mainly used on some exchanges, including Binance, but can be withdrawn onto a private wallet as long as you are whitelisted.

3. What should I use?

There is no simple answer to this question. It really depends on your needs and the kind of risks you are willing to take. If you use a fiat token based on cryptocurrencies, you take the risk that this token could become unused, and thus worthless. If you use a colored coin, you risk being cheated by the asset manager. If a problem occurs with a colored coin, however, you also have the possibility to claim your assets in case of liquidation.

4. What’s next?

So far, we have mainly seen USD-based tokens, and few EUR or CNY variants. As the cryptocurrency market grows, we will see more and more tokenized fiat currencies becoming available. We will also see an increasing number of tokenized financial instruments.

Pushing the concept of stable coins further, users looking for real stability should not place their savings or their liquidity in USD, EUR or any other fiat currency, but instead into a basket of currencies, as Globcoin is doing for example. These concern colored coins, which tokenize the 15 most important fiat currencies.