StablecoinBy Feb 18, 2020 4 Min Read
A stablecoin (or stable coin), as its name indicates, is a stable cryptocurrency designed to be resistant to the type of price volatility synonymous with cryptocurrencies like Bitcoin and Ether.
The key here is understanding "stable": what is "stable"? which references are pegged to make its value "stable"? In terms of what we measure the "stability". We look at stablecoin from various angles.
Typically, a stablecoin is backed by a reserve of fiat money or a basket of fiat money. The reserves that back the value of a stablecoin can also be commodities or assets like gold, bonds, or other stable assets. In real world, we actually measure "stability" using the "US dollar" or the "price level". So depending on the types of reserve backing, we can have different types of pegged stablecoins.
(1) Fiat money reserved, or a basket of fiat money reserved, or its derivatives like bonds.
USDT is currently the most leveraged and claims to be a fully reserved US dollar stable coin issued by Tether. CNH is an offshore Chinese yuan backed stablecoin issued by Tether as well. This value of these types of stablecoins remains locked relative to reserved currency. Think of fiat money reserved stablecoin as a digital certificate of your fiat money, like US paper money was once simply the certificate of gold. Stablecoin is a new form of money.
(2) US dollar measured reserve, typically US dollar, US bond, or US dollar-pegged currencies like Hong Kong dollar.
This type of stablecoin is fiat money reserved stablecoin as well. In our globalized world, the US dollar is the de facto world currency, and almost every other currency is measured against US dollars. So a US dollar reserved stablecoin can be seen as the true "stablecoin". An alternate fiat-backed stablecoin's value could fluctuate drastically if that fiat currency is not stable relative to the US dollar: two examples are the Zimbabwean dollar and Argentine peso.
(3) Other assets reserved.
Typically the other two main types of stablecoins are gold reserved currency and oil reserved currency. PAX Gold (PAXG) is a gold-backed stablecoin. Historically, the original paper dollars were gold-backed, and were actually certificates that proved the gold ownership. "Petro" is an example of an oil-backed cryptocurrency, issued by Venezuela.
(4) Cryptocurrency reserved or a basket of cryptocurrencies.
An example of this is the Dai stablecoin, by MakerDao, which is stable at US $1. However, Dai is backed by Ethereum based smart contracts and stabilized by a number of external market factors.
(5) Mix of the above types.
Libra, as would-be-issued by Facebook, is also proposed to be a stablecoin backed by a reserve of real assets with low-volatility "such as bank deposits and short-term government securities in currencies from stable and reputable central banks"
Typically stablecoin is fully reserved (100% covered by the commodity, or 1-to-1 US dollar backed). But this is not always the case.
If the stablecoin is not fully reserved, it then introduces "credit" and "trust" part of its value and creates "credit money" which increases money supply. This is typically how commercial banks and central banks money issuance functions.
There are regulated stablecoins and unregulated stablecoins. There are obvious risks of using stablecoins that lack any regulatory oversight.
List of typical Regulated stablecoins:
(1) USD Coin (USDC) is the first fiat stablecoin implementation from CENTRE, and Circle and Coinbase are the first commercial issuers of USDC. USDC are held in reserve by regulated financial institutions.USDC is developed on Ethereum platform and is an ERC-20 token. USDC is based on CENTRE, an open-source framework and membership scheme.
(2) Gemini dollar (GUSD) is Issued by the Gemini Trust Company, LLC, a regulated, audited New York trust company and Backed by US dollars held at State Street Bank and Trust Company.
(3) Paxos Standard (PAX) is backed 1:1 for the dollar and it’s issued by the Paxos Trust Company, so the funds are carefully protected, audited and regulated by the New York State Department of Financial Services (NYDFS).
Most stablecoins are issued by companies, including commercial banks with fiat money as the reserve. Examples of pure fiat money backed stablecoins are USDC and GUSD. Facebook's Libra and JP Morgan's JPM Coin are also stablecoins.
An emerging class of stablecoins is being developed by the world's central banks, who have both the power of money issuance and also issue the stablecoin. These will be called Central Bank Digital Currency (CBDC). With CBDC, the central bank will still hold on to the absolute power of money issuance while adopting the advantage of cryptocurrency and blockchain.
Stablecoins make using fiat money( or other assets like gold) in cryptographic form possible as it inherits the benefits of blockchain digital assets like instantaneous money movement, easier payments that bypass the whole "payment-settlement-clearance" circle that makes these services so expensive for traditional financial institutions to facilitate.
Stablecoins bring "stable" values to the cryptocurrency market, where huge fluctuations are not uncommon. As digital asset, stablecoins are easily converted and transacted between other stablecoins and cryptocurrencies. These new class of coin act as a bridge between the traditional financial world and the cryptocurrency world. Currently, most cryptocurrency exchanges offer stablecoin exchange services.
(1) Regulation. In the traditional financial world, there are strict compliance regulations and best practices like Key Your Customer(KYC), Anti Money Laundering (AML), risk management, credit system, or even General Data Protection Regulation (GDPR), etc to overcome.
(2) Financial stability. Due to the convenience and low cost of the flow of stablecoins. Should an unregulated or privately owned stable coin expand and gain mass adoption internationally it could have the potential to disrupt some countries' ability to maintain sovereignty over their currency. There have technical difficulties to ban the "money colonization".
(3) Vested Interest. As financial services based on stablecoins may reduce some roles of traditional financial institutions, private stablecoins, like Libra, will encounter resistance as Facebook, in this instance, would assume the services and functions of a bank. Central banks, in turn, want to extend and maintain their power to be regulated "stablecoin issuers" as well and more traditional banks and other institutions are trying to reap the benefits of the cryptocurrency market too. JPM Coin is one result of their actions.