There is a growing demand for stablecoins, cryptocurrencies that are pegged to a physical asset. With currently more than 50 stablecoin projects in the pipeline, let’s explore more about them.
What Are Stablecoins?
Stablecoins are cryptocurrencies that are backed by physical assets like the U.S. dollar or gold. For every such currency issued, an equivalent value of the asset is held in reserve, and that’s why stablecoins hold their value even in a market downturn. The assets are generally held in third-party banks and are subject to regular audits to establish transparency and trust.
Another form of stablecoin is backed by an algorithm, not a physical asset. Such coins are still experimental. The head of research at Blockchain, Garrick Hileman, said:
They’re really using software rules to try and match supply with demand to maintain a peg to something like the US dollar. As demand for an algorithmic stablecoin increases, supply also has to increase to make sure there’s not an appreciation in the value of the stablecoin. At the same time, as the value decreases, there needs to be a mechanism by which supply can be reduced again to try and bring the price of the stablecoin back to the peg. That’s really the class of stablecoins that are much more challenging to design. They’re really unproven at this point.
Cryptocurrencies are a volatile asset class. The extreme volatility has had critics call crypto-assets as speculative investments rather than currencies or commodities. Stablecoins harness the benefits of blockchain technology (instant transfer and a low fee) and, at the same time, provide stability and trust of physical assets.
The highly volatile nature of crypto-assets makes them a hot commodity for traders. Being able to offer to trade cryptocurrencies for fiat requires exchanges to have a local presence and regulatory licenses to operate. Also, banks are not comfortable dealing with crypto-related entities in the absence of regulations.
The most significant use for stablecoins is on the crypto-to-crypto exchanges in providing these platforms with enough liquidity and enhancing convenience for investors and traders.
Merchants are also hesitant to accept payments in cryptocurrencies given the associated volatility. A digital currency whose price is relatively stable would be more suitable for use in payments.
Future use cases may include more complex financial products like insurance, smart contract dividend payments, and loans being built on blockchain technology.
Currently, Tether (USDT) is the most popular stablecoin and offers dollar-like liquidity on exchanges. It also happens to be the second most traded cryptocurrency globally and among the top 10 cryptocurrencies by market capitalization. Tether, however, has faced a lot of criticism for its lack of transparency and allegations of manipulation.
The demand for Tether has demonstrated the need for stablecoins that can be trusted and are transparent in their operations.
There are about 23 stable coins that are already live, and 57 other projects are under development. These include LBXPeg, the first UK pound-backed stable coin; Gemini Dollar from the Winklevoss brothers of Gemini; Paxos Standard; and the U.S. dollar coin from Circle, the start-up backed by Goldman Sachs.
Investors are betting big on these projects. A report from wallet provider Blockchain has mentioned that “All stable coin project teams have raised $335 million in venture funding to date.” A challenge that stablecoins are likely to face in the future regards scaling since they need to be backed by physical reserves. It could imply having to invest millions or billions in these crypto-assets.
Stablecoins have vast potential and a role to play if cryptocurrencies must go mainstream. What remains to be seen is the innovation the new stablecoins will bring to the table.
What, in your opinion, are the potential use cases of stablecoins in the future? Let us know in the comments below.
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