August 29, 2019
Stablecoins have become an increasingly important category within the blockchain / DLT landscape. More so recently as the term stablecoins hit major news outlets following the launch of Facebook’s Libra and Binance’s Venus projects respectfully. This rising category of digital currencies is particularly interesting as we begin to see new business models introduced and applications (DApps) being launched to leverage their increased capabilities. So what does this all mean?
Let’s begin with the basics — and what a stablecoin is. According to BLOCKDATA, a stablecoin is defined as a cryptocurrency that is collateralized to the value of an underlying asset. They are designed to maintain a stable market price helping to reduce the volatility that is currently seen with other cryptocurrencies / digital assets today. This avoids the market swings of an individual starting the day with $100 USD in digital currencies and overnight see it double to $200 USD then to wake up in the morning and the value is down to $50 USD.
With the reduced volatility stablecoins can allow for more everyday use cases — payments, exchange, storing of value, etc. Examples of assets that may be used to back stablecoins include other currencies (i.e. U.S. Dollar), other cryptocurrencies — or even commodities, like silver or gold. The majority today are pegged to the US dollar with research from Diar showing that stablecoins constitute a $4 billion market cap. The market includes other promising names like DAI, EOSDT, Gemini Dollar (GUSD), and JPMorgan’s JPM Coin, among many others. Each works a little differently to protect and preserve its value.
In the case of Facebook’s Libra, the value will be backed by a basket of stable and liquid assets — such as bank deposits and short-term government securities in various currencies from stable and reputable central banks — which will provide the intrinsic value beginning on day one. Meaning that stablecoins retain their value in ways that Bitcoin and others simply cannot. The $100 USD of stablecoins you deposited today will still be valued $100 USD tomorrow or even the following week.
At the technical level, stablecoins, in general, boasts many of the same benefits of Bitcoin and others, but they offer fewer drawbacks. Stablecoins are built on top of the same blockchain technology, allowing users the ability to conduct transparent peer-to-peer (P2P) transactions without any middlemen involved. These transactions happen with low fees and in some situations, zero fees. They’re also available for use by anyone, regardless of where they are in the world.
Let’s go one further layer deeper on the technical side. Not every stablecoin is the same and currently, fit in one of three categories:
- Asset-Backed On-Chain: Stablecoins backed by cryptocurrencies such as Ether, it is dependent on the stability of the cryptocurrency on the other side of the equation.
- Asset-Backed Off-Chain: Stablecoins backed by a “regular” fiat currency such as U.S. dollar (USD) or euro, precious metals or other real-world assets. It requires trust in an opaque and centralized third party to hold the collateral.
- Algorithmic: Stablecoins relying on a combination of algorithms and smart-contracts to maintain price equilibrium, it requires continual network growth and investment to provide capital and support a falling currency value.
According to research done by Blockdata, the stablecoin market between 2014–2019 has seen over 200 projects introduced. Only ~30% of those projects are live today, with others in-development or closed. Furthermore, 66 of them are currently live (see chart below).
In 2014 we saw the first round of projects launch including Tether, one of the more notable and also controversial. Tether, which is back by the U.S. dollar, uses fiat collateralization, putting a dollar in the bank for every dollar of digital currency it issues. As the market evolved new stablecoins were introduced testing a variety of use cases. During February 2018 Venezuela introduced an interesting use case for stablecoins pegging the coin to one barrel of oil.
The more recent maturity of the market as brought to light, “decentralized stablecoins,” like & Equilibrium_EOSDT & MakerDAO (DAI) which derive their value from the over-collateralization of digital assets. Even though they’re backed by volatile cryptocurrencies, over-collateralization provides users the essential wiggle room to tolerate volatility in the collateral value while the stablecoin’s value remains unchanged. EOSDT, for instance, is currently overcollateralized at 170% — this means that the underlying collateral could decline by 70% before any action is necessary to protect this coin’s value.
Key a close eye on the maturity of the stablecoin market. Its role in the blockchain landscape will continue to increase as the rate of adoption grows, new use cases (gaming, entertainment, retail, unbanked, etc.) are introduced and the technology stack strengthens to support their scale (frameworks, DApps, networks, etc.). Stay tuned.
More Stablecoin Resources:
- George Samman & Andrew Masanto — The State of Stablecoins 2019
- Jose Garay — https://medium.com/witnet/the-next-step-for-stablecoins-decentralized-oracles-da12e0792fc
- Linda Xie — https://lindajxie.com/2019/08/23/where-stablecoins-are-headed/
Author note: I am involved with the Equilibrium project mentioned in this article. I do, however, provide insights and research on the greater blockchain, DLT, & DApps landscape.