Understanding Stable Coins: What You Need to Know

JP Morgan is the first bank that has launched a stable coin. JP Morgan’s first engagement with blockchain was the Interbank Information Network (IIN) which saw 176 banks worldwide join IIN since its inception in 2017. JP Morgan coin (JPM coin) has been created to instantly transfer value; it will only be accessed by wholesale customers and will be permissioned on the private blockchain. It will be used for international payments without wire transfers, for securities transactions and for treasury services. IBM too has come up with ‘Stronghold’ stable coin while Facebook wants to introduce one through WhatsApp.

“Stable coins” is a cryptocurrency term that is used to describe cryptocurrencies which are meant to hold stable values. Also known as “holy grail of cryptocurrency,” stable coins are price stable crypto-currencies and have a market price that is pegged on to another stable asset like gold or the US dollar. They are global currencies but are not tied to any central bank. While they share many of the features inherent in bitcoin, they are not as volatile as bitcoins. It is not surprising to see an increase or a decrease of 10-20% in cryptocurrency prices. This makes it inconvenient to use cryptocurrencies for daily transactions.

• Take for instance if you bought a shoe at 10$ only to meet with a 20% downward fluctuation in cryptocurrency price; the consumer will have lost. Theoretically, this enables stable coins to be practically more usable (like paying for bills and transactions daily) and ideal as a basic medium of exchange and store of value. The adoption of stable coins will be a catalyst to mainstreaming the novel decentralized internet.

According to Rafael Cosman, the founder and CEO of TrustToken, stable coins help bring the benefits of cryptocurrencies to everyday life. They include decentralization of capital and stabilization of cryptocurrency prices that are often volatile. For a cryptocurrency to operate on an optimal level, it needs to have the following characteristics: stability, price, scalability, decentralization and privacy. Other additional traits that would be desirable include: easy integration points for partners, the elegance of concept and ability to have the cryptocurrency in an exchange; but of all the above, stability is key. In the short term, stability is key for efficiency in transacting while in the long term, stability is critical for holding.

Each stable coin has a unique way of operating; although they all work generally the same. It could be backed by other currencies, reserve-backed or algorithmic. The first type is backed by cryptocurrencies as the name suggests; they use cryptocurrencies as collateral instead of fiat money. When it is done on the blockchain, it eliminates any third parties. The challenge is that it introduces the aspect of volatility so that creators of such stable coins have to make extra currency deposits to cushion for volatility.

• Reserve-backed stable coins also act like fiat currency; they are backed by the USD like the case of TrueUSD and Tether. Algorithmic stable coins, on the other hand, are controlled by algorithms. Software controls the increase and decrease of stable coins to maintain a given balance in the market.

The stable coins hold some type of collateral and they manage supply so as to incentivize to trade crypto coins for no more and no less than $1. For some stable coins like Tether or TrueUSD, they operate on the concept of holding actual dollars in reserve which are redeemable in exchange for the token. Other stable coins like Dai, crypto assets are held in reserve and are exchanged through a lending system.

Stable coins may be the best way for companies and start-ups to raise capital thanks to their flexibility, stability and ability to be pegged on various world currencies. They could revolutionize digital business. In essence, stable coins could help enterprise in the following ways:

1. Flexibility

Stable coins are based on the blockchain technology and this means that companies and start-ups can easily manage funds and in a rapid manner without international barriers. There are no intermediaries involved when it comes to checking, processing, and verifying payments and transfers.

The implication is organizations will be able to carry out transactions across the globe and save a significant amount of money in inter-bank transfer fees.

2. Stability

Enterprises will no longer have to worry about volatility, a characteristic of most cryptocurrencies as stable coins are backed on real world assets, thus provide market stability.

3. Raise capital

Stable coins unlike cryptocurrencies mean that investors can easily and safely invest in start-ups while entrepreneurs can likewise move funds back to investors. All this is possible without the need of third-party involvement (think legacy banking systems).

Additionally, companies and start-ups will be able to reach investors from all over the globe in a genuinely peer-to-peer relationship, rather than simply locally. As a result, this provides companies and start-ups with far more potential for growth.

Before one goes into stable coins, they need to consider the following:

❖ Historically, most stable coins fail

While this does not speak to the current stable coins, history has seen the majority of the stable coins fail. And when it actually happens that they fail, users/owners have not been able to redeem the promised amount. None of the stable coins that have existed previously is still in existence except for Nubits which have recently been trading for less than 0.50cents. Currently, TUSD, Tether and Dia among others seem to be strong; probably they have learnt from the bitter history that is associated with stable coins.

❖ Stable coins as a source of stability for cryptocurrencies seems to be theoretical

The above idea has not been empirically proven; it appears that stable coins enhance the ability for traders to go on to dollars and for exchanges to increase stability. But as for stability; it may seem that stable coins are increasing volatility because they allow for more speculation. Theoretically, speculation should lead to stability but practically, it increases volatility.

❖ With stable coins, there is a need for trusting a third party

Even when stable coins are blockchain based, each stable coin has a way of being overly centralized in a bid to manage its assets as well as ensure stability. Anything that is centralized requires participants to trust a third party which goes against the very essence of blockchain and cryptocurrencies.

❖ Illegitimacy claims for Tether stable coin

Tether is one of the well-known stable coins in the market. Its creators claim that it is pegged on the USD, meaning that a user would transact 1 Tether for 1USD. But the cryptocurrency exchange Bitfinex has issued more Tethers than it has issued USD. Many speculate that this could be an attempt at driving up bitcoin prices.

Additionally, Tether as a company has faced allegations of illegitimacy due to transparency issues; no external audit has ever been performed on the company’s cash reserves. The company ended its relationship with its auditor just when the auditor was about to release its audit report on the company.

TrueUSD tokens make use of the escrow to hold funds. This helps it comply with Anti-Money-Laundering regulations as well as safely hold TrueUSD for its clients. TrueUSD users have to complete Anti-Money-Laundering and Know Your Customer (AML/KYC) before they are able to purchase the tokens or even redeem the USD in the escrow account.

• They make use of smart contracts to verify ownership and issue tokens which also acts as a redeemable certificate of ownership for each USD in the escrow account. Further, TrueUSD also publishes Cohen & Co. attestation reports regularly to confirm that the amounts of TrueUSD in circulation are fully collateralized in USD. And from the CoinMarketCap charts, TrueUSD’s price has remained stable at around 1$.

Examples of stable coins include Tether, TrueUSD, MakerDao, Havven, and Basecoin among others.

A working stable coin (s) is badly needed to open up the cryptocurrency world to daily usage. We’ve seen even though cryptocurrencies are fast and efficient, they are very unstable- a high-risk/high-reward investing option. Hence the need for stable coins; they represent a significant shift in the market, a route to immense longevity tied to real-world assets. Great strides have been made in this regard and much more needs to be done if stable coins will solve the problems of stability and liquidity.