How Stablecoins Function in the Crypto Ecosystem: Trust Through a Third Party
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Stablecoins seem to be the latest wave of hype in the crypto world.
2013-2014 was all about Bitcoin alternatives. 2017-2018 was all about ICOs. And now we’re seeing a surge in private centralized companies offering additive technology to smooth out the volatile fluctuations in value so commonly associated with cryptocurrency.
Stablecoins are blockchain-based digital currencies like Bitcoin and Ether, except they’ve been created for the purpose of maintaining a stable value.
Stablecoin price feeds are pretty boring by comparison to the swings of conventional cryptocurrency. $10 in stablecoins today will always be $10, whether you fast forward to tomorrow or a year from now. They achieve stable prices using a number of different methods, but the most common is to peg a stablecoin to fiat currency or another commodity – the US dollar is a popular favorite.
This means they behave something like cash on the blockchain. You don’t have to worry that the cash in your wallet today will suddenly be worth a different amount next week. The value of your cash holdings only changes as you spend or acquire more cash.
Stablecoins take the blockchain technology component that makes Bitcoin great and pairs it with stability. For many people, these two characteristics come together to make a great financial product, but it comes at the cost of decentralization. Stablecoins are distinctly more centralized than their conventional crypto counterparts, but they’re not necessarily trying to be decentralized. This makes them far less auditable.
In a strong clash against how Bitcoin works, not all stablecoin data is public.
Bitcoin’s decentralized ledger lets people transact in a trustless fashion. But stablecoins require that you trust the company furnishing a certain token to operate the way it says it operates.
Tether is a compelling example here. As a fiat-backed stablecoin, the company says it has a dollar in the bank to back every single one of its tokens in circulation. But this has proven to be a highly controversial statement and the company has been embroiled in accusations of “printing” stablecoins out of thin air. It’s not exactly a trustless situation. (For being pegged to the US dollar, it’s unusual that Tether’s trading history shows prices as low as $0.92 and as high as $1.21.)
But Bitcoin is immune from these kinds of problems because virtually all of the data associated with a transaction – the sending and receiving wallets, as well as the amounts — are an open book ready for audit.
There are still some strong use cases for stablecoins.
It’s easy to imagine a new-and-improved Western Union style of service for sending and receiving money around the world nearly instantaneously. Bitcoin already lets you do this without any middlemen involved, but if you don’t cash out in a timely fashion, your received BTC may be worth a different amount by the time you visit an exchange. A trustworthy stablecoin can still eliminate fees and cut out the middlemen while also putting time on your side – the best stablecoin price feeds are boring straight lines.
Meaningful business use cases require steady footing, and that’s why the emergence of stablecoins seems to be catching the crypto world’s attention lately.
Take it from Rune Christensen, the founder of the MakerDAO stablecoin platform.
“Stablecoins are the first step before you actually see anything else interesting happening because you just cannot do business in an unstable environment.”
Stablecoins might be an excellent on-ramp to crypto, but they still add a layer of complexity to the field.
The simpler system for moving coins from A to B will always be Bitcoin. The stablecoin paradigm requires a company’s guarantee that its technology will behave appropriately, and that company might decide to start abusing its power at any moment. Stablecoins might be a useful place for day traders to store their accumulated value overnight in order to sleep a little easier, but they still end up having to trust a third party.
Just as cryptocurrency is finding its place in the world, stablecoins are emerging to find their place within cryptocurrency. The profit-seeking motive that pertains to crypto mining is completely nullified here, so it will be interesting to see what niche or unignorable “killer app” stablecoins fill.
Until then, they’re a useful application of blockchain technology that enables transacting without any price anxiety involved. We’ll see what the next wave of hype brings into the crypto community.
Philip Salter, head of mining operations, Genesis Mining