The launch of Libra by Facebook has brought to the fore the role of stablecoins in the development of the cryptoasset industry. Stablecoins are a category of cryptoassets that seeks to maintain stable value to a reference asset. In the case of Libra, it will be pegged to a basket of fiat currencies and government-backed securities.
According to research by Blockchain.com, stablecoins are already an important part of the cryptoasset ecosystem. There is a total of over 57 live and pre-launch stablecoins, with a total market value of $3 billion, or 1.5% of the total market value of all cryptoassets. Tether, as the most actively traded stablecoin, has a daily trading volume equal to approximately 60% that of Bitcoin.
There are many reasons to use stablecoins. Some of the earliest use cases are in trading. Stablecoins are useful on exchanges that don’t offer fiat trading, as they can be used as a quote currency for trading pairs. They may also offer exchanges the opportunity to develop a robust ecosystem of products and aggregate users by issuing their own stablecoins. Finally, stablecoins provide traders a stable asset to park cash and a short-term store of value.
On the other hand, stablecoins have bigger, multi-trillion dollar opportunities. It could open up money and payment networks based on cryptocurrencies for business and commerce, as price stability is the key missing piece they fill for merchants and retailers. They may also fulfil the role of store of value, especially for citizens of unstable monetary regimes such as Argentina and Venezuela, who can find refuge in a stablecoin pegged to a more stable currency or commodity (such as USD or gold).
Perhaps the most exciting opportunity are the programmable and decentralized applications (dApps) that can be built on top of stablecoins to create a digital ecosystem. These dApps will create everyday experiences and operate with stablecoins as tokens. Examples include gaming, prediction markets, financial services, content production, and more. They are channels through which stablecoins can be brought to the masses and companies (like Facebook) can create a robust system of users and applications.
A wide variety of stablecoin designs have been developed, but in general one can identify three major design types: 1) traditional collateral; 2) crypto collateral; 3) algorithmic.
The most basic form of stablecoin involves an issuer holding an off-chain, traditional asset like fiat currency or commodity, and issuing a token that represents each unit. A token is essentially a 1:1 IOU for the asset held in reserve. Tether (pegged to USD) and potentially Libra (linked to a basket of major fiat currencies) are examples of such IOU systems. In this design, participants are required to trust the centralized issuers, who may position themselves as trustworthy by making their operations more transparent with regular audits or even regulatory oversight.
Then we have the crypto collateral type, which uses on-chain assets like Ethereum as collateral. This solution often involves overcollateralization to build a buffer against downward price swings in order to protect the peg. As both the stablecoin and collateral are on-chain, everything is publicly auditable with no requirements to trust a single counterparty. MakerDAO’s DAI, backed by Ethereum, is the most well-known example of this category.
Finally, algorithmic stablecoins are uncollateralized and rely on mathematical mechanisms to balance coin supply and demand and achieve price stability. However, the success of this category is still unproven, and some believe they may need some collateralization after all to achieve stability.
Trust and Centralization
Paradoxically, stablecoins may not be fully aligned with the trustless philosophy of crypto evangelists, as they rely on centralized issuers. However, the market today appears to have prioritized stability over decentralization. In fact, fiat-backed designs are far more prominent than crypto-backed or algorithm-based stablecoins. Tether alone accounts for approximately 98% of total stablecoin daily trading volume.
It is not difficult to understand why. If price stability is what market participants most value, it can be best achieved by a more centralized design. More automation, decentralization, and transparency generally carries with it the trade-off of greater complexity and less stability (i.e. higher likelihood that the peg will be broken). However, while the market prefers stability over decentralization in the near term, this does not preclude experiments with more decentralized stablecoins in the future.
With price stability and regulatory compliance, stablecoins may be one of the first cryptoassets to achieve mass appeal and adoption. It is the ideal bridge and educational tool for the general public to transition into the crypto and tokenized economy. We are likely to see the continued growth and competition of stablecoins in 2019 and beyond.
At the same time, this trend will be driven by big corporations looking to achieve user aggregation, ecosystem development, and ancillary product synergies through stablecoins. We see Facebook’s Libra as an obvious example in social media and e-commerce. In financial services, JPMorgan has launched JPM Coin, looking to apply it to wholesale business payments. And Goldman Sachs is following suit. Its CEO David Solomon summarized the potential prospects of stablecoins well, “assume that all major financial institutions around the world are looking at the potential of tokenization, stablecoins and frictionless payments.” The outlook, in short, is exciting.