Stablecoin: what is it and do we need it

How are they different from bitcoin and do they actually have any benefits?

Stablecoin: what is it and do we need it. Source: shutterstock.com

The cryptocurrency market is buzzing about a new type of virtual asset. It is called stablecoin and comprises a number of existing cryptocurrencies. How are they different from bitcoin and do they actually have any benefits? That’s what we are determined to examine.

What is stablecoin

Stablecoin is a generic term for any cryptocurrency, the value of which is linked to a stable asset.

Such sources of stability may be fiat currencies, precious metals, or others. Some popular stablecoins are Tether, Basis, Saga, Carbon, Maker, and TrueUSD. Their value is backed by the real-life dollar deposits and have a stable equivalent in US$. The main prerogative of stablecoins is their resistance to volatility. However, many people see it as a violation of the basic foundations of crypto space.

While the initial bitcoin ideas were decentralization and independence from state monetary systems, more and more crypto-investors look for asset security and appliance to the perceptible goods. Paradoxically, this led cryptocurrencies back to the reliance on fiat money.

Paradoxically, this led cryptocurrencies back to the reliance on fiat money. Source: shutterstock.com

This way, while some people refer to stablecoins as the ultimate solution to the cryptomarket’s uncertainty, others see it as a step back towards the biased dependent monetary system. Whether we need stablecoins or not is a tricky question. Let’s consider some crucial factors while reminding ourselves about last year events around bitcoin.

Bitcoin was labeled too volatile when its value in US$ swiftly changed within a 10% range during the same day. Despite its recent stabilization, people still remember that market frenzy. In this respect, bitcoin is opposed to the US dollar. The latter can adjust to population demand with inflation, while bitcoin doesn’t have any adjusting mechanisms. Therefore, the price changes are inevitable and unpredictable.

The future of bitcoin may be predicted with an analogy of gold. Source: shutterstock.com

The future of bitcoin may be predicted with an analogy of gold. Both assets have an inflexible supply, both have a low inflation rate irrespective of market trends. At the same time, gold has managed to remain the most stable financial asset over the centuries, while paper currencies come and go. Perhaps, bitcoin can become the ultimate crypto store of value too. However, this process may take a long time especially when people increasingly demand stability.

Bitcoin futures give “cryptopurists” a ray of hope. Their rapid growth promises better risk management and hedging market instability. Last autumn, the main bitcoin swaps such as Bitflyer, Bitmex, Deribit, and Crypto Facilities jointly traded at an average rate of $2.2bn a day. CME bitcoin futures also grew significantly.

Futures and other derivatives remain a fair hedging instrument with linear exposure to the underlying assets. Source: shutterstock.com

Emerging in the 19th century, futures and other derivatives remain a fair hedging instrument with linear exposure to the underlying assets. Whether a company produces goods or mines bitcoin, they cannot stop at selling the futures contract to break even. They must also reject the rise of financial income. This gives investors the time and possibility of a put option. For cryptocurrencies, adopting such regulation mechanisms will attract more shareholders.

When investors become more secure, hedged against instantaneous price volatility, panic share sales will be less probable.

The main areas of the cryptocurrency market that require hedging mechanisms are: handling the cryptocurrency production; providing hedging solutions to major vendors and individual consumers utilizing bitcoin; mass selling mechanisms adding market depth. If global institutions follow small retailers by investing in the cryptomarket, they are more likely to hold those assets during the long-term. This will help volatility gradually decrease. However, the crypto space must provide some yield option to make it possible. Savings interests may be a good idea. It is much more tempting for bitcoin investors to see their assets multiplying over the long term.

Bitcoin has a chance to reduce its volatility in a natural way. Source: shutterstock.com

Taking this hedging trend into account, bitcoin has a chance to reduce its volatility in a natural way. Many traditional markets have already experienced the “pinning” effect when very volatile stocks stabilized after the release of structured derivatives. Therefore, introducing additional stability to cryptocurrencies may be a hyper-protection method.

Moreover, many critics dispute the viability of existing stablecoins. Despite the lofty claims, there is no proof of the dollar deposits actually supporting their circulation. At least, the announced audit that was supposed to check Tether assets didn’t take place. That immediately raised suspicions. People wonder where the cash behind the stablecoin comes from if it exists at all.

If one virtual coin equals one actual dollar, someone must invest this perfectly reliable amount of money launched by the US government to convert it to cryptocurrency. That seems dubious to many, as crypto coins have little value as either units of account or a store of value. Only the owners of illegally obtained money would be interested in that, so it might not get approval by the governments.

Cyptocurrency that is fully backed by US dollars can be redeemed at any time. Source: shutterstock.com

Although cryptocurrency that is fully backed by US dollars can be redeemed at any time, people have more attractive ways to invest money. Most savings bring more profit with interest than owning a potentially shady stablecoin. Ordinary cryptocurrencies seem less controversial in this respect.

As for the partly collateralized stablecoins, this system is very shaky. If some part of the owners starts selling their holdings, the dollar reserves become too limited, and other investors are tempted to leave as well, leading to the collapse of the peg. Not to mention the uncollateralized stablecoins supported by the crypto-bonds. There is no guarantee at all that those will attract enough investors to buy those additional bonds aimed at keeping the price stable. These issues are common to every pegged exchange rates system. Sooner or later stablecoins may experience hardships too, so their stability is really under threat.

All in all, stablecoins mean to find a balance in the cryptomarket between independence from national authorities and price steadiness. However, one cannot truly speak of decentralization when the assets are fully related to the reserve of banknotes issued by the federal government. Moreover, the mechanisms of stabilization are not very reliable in the long run. In this respect, the natural stabilization of bitcoin with the help of futures hedging may become more attractive than stablecoins after all. Meanwhile, stablecoins are a good short-term solution for prudent and practical investors.

SEE ALSO: Stages of the blockchain revolution

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