Are they actually stable and why should we care?
Regardless of interest, or lack of, in cryptocurrencies, the one thing pretty much everyone knows is that they’re volatile. Prone to monumental crashes and swift, significant upswings, Bitcoin has been known to go up or down by 20 per cent in a single day.
Given this wild unpredictability, widespread adoption of cryptocurrencies is looking unlikely to happen any time soon. Imagine paying £5 for your hot chocolate on your morning commute only to find out if you’d bought it in the afternoon it would have been £4. Consumers and businesses simply wouldn’t have it.
However, there may be a solution. Stable-coins, as the name would suggest, are more stable versions of cryptocurrencies. Pegged to another stable asset, such as gold or a fiat currency like sterling, they make the most of the decentralised benefits of cryptocurrencies and have lower volatility. If they become adopted by the mainstream, we could pay for things using digital currencies on a practical day to day basis. Digital currencies that are easily trackable on a public ledger, meaning the risk of fraud and identity theft is significantly reduced.
That’s the theory at least. There are however many conflicting views as to whether stable-coins will actually calm volatility in the space or whether this can only be done with a significant increase in liquidity over a long period of time. There also hasn’t, as of yet, been a clear universal “winner”; a stable-coin that has distinguished itself above the rest, though there are a number of projects trying to do exactly that.
The waters start to become murky though as there are three different types of stable-coin emerging, dependent on what asset the digital currency is tethered to.
Fiat-collateralised stable-coins are, naturally, backed by fiat currencies, the most famous at the moment being Tether. Its makers claim that for every digital coin, they have the equivalent US dollar held in reserve. Debatable but that’s a different discussion. This type of stable-coin is centralised to a large degree, and as such many traditionalists in the space are reluctant to back them due to the lack of decentralisation – a core part of the original crypto ethos. On the other hand, there are those who believe this “middle-path” is the only way banks will adopt digital currencies moving forward.
Crypto-collateralised stable-coins are backed by a pool of crypto. Users of this type stake an amount of crypto and then borrow stable-coins against that collateral at a fixed rate. One of the most popular coins of this kind is called DAI, controlled by the decentralised organisation Maker. The main challenge to crypto-collateralised stable-coins is that they can still be vulnerable to significant price spikes and drops in the market. However, they do hold true to the decentralised architecture that is so central to digital currency’s core, making them highly resilient and difficult to commit fraud with.
The third and final type is algorithmically controlled stable-coins. This is a relatively new model, that uses complex algorithms to adjust supply based on demand to maintain a consistent price point. The key difference between this stable-coin and the other two is it’s not trying to be a new version of the fiat reserve system; no collateral is put up at all. The big issue, however, is that the entire system is based on trust; though, with the likes of Basis, trust is placed in software controlled by algorithms on the network, not humans. And only time will tell whether placing trust in an algorithmic system is a good idea.
Ultimately, the idea behind stable-coins, whether fiat, crypto or algorithmic, is sound. Volatility in the market is a huge barrier to mass adoption and until this is overcome, we won’t be buying our morning coffee with cryptocurrency. If we want the benefits digital currency could bring – trackable money, reduced identity fraud and theft – then we need to work on creating a truly stable cryptocurrency that mitigates all the current risks associated with cryptos.
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