untitled design

What you need to know about stablecoins?

In the fall of 2013, the financial world entered a new reality. To the jubilation of cypherpunks, bitcoin soared above $ 1000, and central banks around the world began to publish warnings and look for ways to pacify the “decentralized genie” that threatens the stability of the familiar system, writes RBC Crypto.

The rise of cryptocurrencies has been halted by a lack of trust and, as a result, high volatility. A reliable tool was needed to stabilize the price of digital assets. This is how “stable cryptocurrencies” – stablecoins appeared. This tool has helped connect cryptoassets to the real world. Almost simultaneously, two different approaches to creating a stable cryptoasset began to develop.

Fiat-backed stablecoins

The first and most common type of stablecoins is backed tokens on public cryptocurrency blockchains. The very first and most popular of the existing stablecoins – USDT (Tether) – appeared in 2014, and at the beginning of 2021 its capitalization exceeded $ 25 billion.

The vast majority of stablecoins pegged to fiat currencies are denominated in US dollars. They have occupied a vacant niche as a cryptocurrency instrument with minimal volatility. All of the most popular secured stablecoins are issued by cryptocurrency exchanges:

USDT — Bitfinex;
USDC — Coinbase;
BUSD – Binance;
GUSD – Gemini.

Issuers of classic stablecoins declare their backing in real dollars in a bank account or a package of government bonds in a 1: 1 ratio. Therefore, 1 token almost always costs 1 dollar, its price rarely deviates by more than tenths of a percent. But it’s not that simple. The real security of such stablecoins is not always possible to verify, you have to trust the issuer’s reporting – a cryptocurrency company, often registered offshore.

Users of fiat-backed stablecoins hardly think about their actual backing, as the usability exceeds all doubts and risks. Their price stability is supported by trust, almost without the use of market or technical methods.

The main thing about the essence of “secured” stablecoins. They have a centralized issuer – an organization that bears economic and legal responsibility, and the provision of fiat currency in a bank account. In fact, these are not cryptocurrencies, but tokenized fiat – electronic money on the blockchain. Conceptually, they are similar to payment systems such as PayPal or Webmoney. From a technical point of view, their main difference is the transparency of transactions, since they pass through public blockchains.

Algorithmic stablecoins

Decentralized or algorithmic, stablecoins appeared even a little earlier. The first of them were launched on the Bitshares blockchain back in 2013. Their security consisted exclusively in the basic blockchain token – BTS, due to its volatility, these stablecoins were not stable enough.

The most popular decentralized stablecoin in existence, the DAI on the Ethereum blockchain, launched in 2017. The peg to the US dollar is supported by market and technical mechanisms based on smart contracts that implement a price stabilization algorithm. Therefore, stablecoins of this type are called “algorithmic”.

An algorithmic stablecoin runs on top of a public blockchain backed by its underlying cryptocurrency, such as ETH. The security in the form of ether is blocked in a smart contract and a crypto asset is launched on its basis. Price stability is achieved by the Collateral Debt Position (CDP) mechanism and collateral redundancy reaching 50% on average. When redeeming tokens, the user receives ETH back into their wallet.

Thus, with the help of price regulation algorithms, a stable crypto asset is created without the participation of fiat currencies and the need for communication with the traditional financial system. Algorithmic stablecoins work like cryptocurrencies. Unlike USDT and its counterparts, they are decentralized and not subject to a single issuer and regulators.

The crypto industry is now dominated by secured stablecoins. The mechanisms of their work are more understandable to people, since they are close to the already familiar electronic money. In the event of market shocks, they better hold up to the dollar peg. Pegging algorithmic stablecoins in times of crisis works less well and is more volatile.

Another significant factor is that USDT has taken a serious niche in the real economy. For example, in the transfer of money by market traders from Moscow to China and international transfers in many other countries. Instant transfers, low commissions and the absence of KYC / AML procedures on many exchanges make classic stablecoins a very convenient tool.

Algorithmic stablecoins are widely used within the DeFi industry, but so far they cannot go beyond it. They have yet to find application in real economic transactions.

Government and bank stablecoins

Central banks immediately perceived cryptocurrencies as a potential threat to the stability of the financial system, monopoly in monetary emission and a reason for a possible drop in demand for reserves in fiat currencies. In late 2013 – early 2014, most central banks issued initial statements and warnings about cryptoassets.

After several years of monitoring the cryptocurrency market, the central banks of most countries came to the need to control the turnover of crypto assets and regulate business. For their part, central and commercial banks are working to issue stablecoins like Tether.

The concept of issuing digital currencies of central banks (CVCB, or English CBDC) is understood by the Central Bank, since they are very close to ordinary non-cash money. There is a movement towards the creation of projects that will be fully controlled by the Central Bank and all operations will be transparent to the regulator.

By issuing CBDCs, central banks aim to create a controlled, secure and stable monetary system that will reduce incentives to create cryptocurrencies and other private money. In contrast, CBDCs will be supported by central banks in a similar way to local currencies and will have legal tender status.

Current status of CBDC

As of today, there are two already issued government cryptocurrencies. Venezuela was the first to issue the state digital currency Petro back in 2018, but its turnover is not transparent, and its provision and application in the real economy is seriously questionable. At the end of October, the Central Bank of the Bahamas issued the Sand Dollar token. It is regulated similarly to the Bahamian dollar and is accepted throughout the island nation.

In January 2020, the Central Banks of the European Union, Great Britain, Canada, Japan, Sweden and Switzerland, together with the Bank for International Settlements (BIS) and the Financial Stability Board (FSB), began work to jointly study and coordinate the release of CBDCs. In 2021, the EU plans to start experimenting with CBDC.

In October, the Bank of Russia presented plans to create a digital ruble. And in China, a pilot project is already underway to test the digital yuan in the real economy. The US Federal Reserve has been conducting research for several years, but the timing of the release of the digital dollar has not yet been determined.

Stablecoin development trends

From an end-user perspective, CBDC and bank tokens are very similar to fiat-backed stablecoins. Therefore, these three groups of assets will compete directly and try to oust each other from the market.

The main advantage of private bank stablecoins is the large reach, user base and solid reputation of traditional financial institutions. People will use them in the same way as other banking products, in the same applications. Therefore, stablecoins from private companies such as JPM Coin and Libra raise serious concerns among regulators.

Traditional crypto-stablecoins in such a company may not be in demand. They will probably survive, but they will be under a lot of pressure and the RPM will drop markedly. Their functions will be taken over by banks and CBDCs, while rivals will not experience a lack of trust.

CBDC has the strongest positions due to the administrative resource. Regulators have already managed to significantly slow down the release of Libra, and, perhaps, the token will not appear on the market until all legal issues are resolved. The state will completely take away the niche of “electronic money on the blockchain”; it does not need outside players in this area. This process is already taking place in China at the pilot level – millions of Chinese in several regions use the digital yuan, and their number will only grow.

The widespread adoption of CBDC and the abolition of cash is very interesting for governments. This is a real base for the financial infrastructure of the state of the XXI century, when there is complete control over all operations, cash flows of individuals and companies. At the same time, physical checks are not needed, all movements are technologically visible, it is impossible to hide anything. Other Central Banks will sooner or later come to this concept, at different levels of control and a possible degree of privacy for citizens.

The crypto community will respond to the strengthening of state control with new projects of decentralized stable crypto assets. It is in such a confusing situation that advanced algorithmic stablecoins that are independent of banks and regulators can prove themselves. In the crypto industry, they will take over the functions currently performed by USDT and other secured stablecoins. They will become real stable cryptocurrencies, not electronic money.

The next step is a new blockchain with a stable price and very low volatility, which can be used like a regular fiat currency, but without pegging to the dollar or euro. We need mechanisms for the stability of cryptocurrencies built into the architecture of the blockchain, and cryptocurrencies with an initially stable price, and not a superstructure over something volatile. Their main goal will be to abandon the peg to the dollar or euro.

To create them, a mechanic similar to traditional bond-based markets is possible – similar to how the dollar is backed by bonds (Treasury bonds). This requires a token to appear on the blockchain with built-in stability. Such mechanisms have not yet been developed.

On the other hand, against the backdrop of a pandemic and accelerated emission, fiat currencies are depreciating more and more rapidly. Now the option of the dollar falling several times no longer looks fantastic. The very pegging of cryptocurrencies to falling fiat currencies becomes dangerous and unnecessary. And if, in the next five years, a stable cryptocurrency appears with the same volatility against the dollar as, for example, the Swiss franc, it will be able to go global and become the basis of a truly decentralized financial system.

You may also like

Get the latest

Stay Informed: Get the Latest Updates and Insights

 

Most popular