One of the least discussed pain that comes with cryptocurrencies like Bitcoin and Ethereum is their extreme volatility. One day you are on top of the world because you caught an early sniper entry for the week, and the next day? Yes, you guessed right, the next day your wallet is bleeding red and your fortune has been converted to gas fee. Now, I am not a very big fan of stablecoins but this is where they start making sense. Why? Because stablecoins were specifically designed to solve the volatility problem from cryptocurrencies! Now, there are cases when even some stablecoins fail but they are not very common.
Stablecoins act as a bridge between the old fully centralized financial systems and the world of digital assets. And one good thing about stablecoins is that they offer the speed and global access of crypto but with lesser price swings. I believe that stablecoins are the critical infrastructure that is key to enabling mainstream adoption of crypto. Let’s dig in and find why I am starting to believe in stablecoins.
What are stablecoins?
Stablecoins are cryptocurrencies that have their value pegged on another asset such as a fiat currency. The goal is that one unit of the stablecoin remains worth 1 unit of the fiat. There are cases where stablecoins may depegg from the peg due to several circumstances.
Just today I was reading on X about the USDX stablecoin depegging to around $0.83 instead of maintaining 1 dollar value. This resulted in a great loss in value and it remains to be seen if the coin will recover as per the time of writing of this draft.
Types of stablecoins
The truth is that not all stablecoins are the same. There are different types of stablecoins.
Fiat collateralised stablecoins are the most common. For each digital stablecoin, there is a corresponding fiat currency held in a real bank account by a real central entity. USDC from Circle and USDT from Tether are the most common fiat collateralised stablecoins. Fiat pegged stablecoin issuers have to obtain licences from regulatory authorities and be audited for proof of reserves.
Crypto collateralised stablecoins are backed by baskets of cryptocurrencies. To protect against the collateral’s own volatility, the stable coins are over collateralised. For example you would need $1.50 of Ethereum to back $1.00 of the stablecoin. DAI from MakerDAO is an example of such a stablecoin. Due to its decentralised nature, it has become a key player in DeFi.
Algorithmic stablecoins tried to maintain their peg using complex algorithms through creating and destroying coins. However, these have the highest rate of failure and depegging. The dramatic collapse of TerraUSD in 2022 showed the immense risks of uncollateralised or poorly designed stablecoins.
The critical role played by stablecoins in the digital economy
Stablecoins are known as the backbone of the digital currencies economy.
Stablecoins are a haven for traders. As the crypto markets operate 24/7, traders need a quick and reliable way to exit their volatile positions without converting back to currency because it may be impossible, slow or expensive. So, stablecoins are the digital cash for selling and parking a traders funds while waiting for new opportunities. Traders use billions of stablecoins for this purpose on a daily basis.
They also make the backbone of decentralised finance (DeFi). Users can land their stablecoins on platforms like Aave and Compound to earn interest rates that can surpass traditional savings accounts. Stablecoins are also the primary medium for exchange on decentralized exchanges, (DEXs). They act as a grease to help the DeFi machine to run.
Stablecoins are also revolutionising cross border payments. If an intern in Mexico wants to get paid by a client in the U.S. It would take 3-5 days with a bank wire transfer. In addition to the longer time taken, the transaction charges of tradition systems are high (between 5-7%). Not to mention currency conversion losses. However, with stablecoins, a client can quickly send digital assets in minutes with a network fee that is usually less than a dollar.
Stablecoins offer a programmable money solution. This concept is futuristic but beneficial as stablecoins are built on smart contract platforms which makes them programmable. This means you can set up a payroll that automatically pays employees in stablecoin at a particular date every month. Governments can issue funds to departments with expiry debts to encourage spending. This feature has great potential in the financial sector.
The future potential of stablecoins
There are several reasons why stablecoins have a great potential in the future. And if nothing changes in the digital economy, they can grow beyond the current crypto market.
Stablecoins are suitable for everyday commerce. With a wider adoption, you can pay for your coffee, groceries or online subscriptions with digital currencies. This would be more beneficial for consumers as transactions would be very low cost and near instant. However, for this to be possible blockchain networks must be more scalable and acceptable in the broader global economy. Companies like Western Union, mastercard and VISA are already running pilots.
The reason why many people fear cryptocurrencies is their high volatility, this is especially true for new users. Stablecoins however offer a safe space for crypto exploration without losing their value due to volatility. Just like fiat, users are assured that their funds are safe and cannot lose value overnight.
Central bank digital currencies are being launched and planned by governments as their own digital currencies. It seems like governments are tired of watching the rise of private stablecoins and they now want to be part of the action. The interest of governments gives a validation of the stablecoin concepts. As a result, we now know that the future of stablecoins is inevitable, it's just a matter of when they will be issued by whom.
The challenges with stablecoins
While stablecoins might look like the super problem solver, there are also a lot of significant challenges that may affect their use.
While Europe is leading in regulation with MiCA and the U.S. is trailing with its Genius Act, regulatory uncertainty remains the biggest obstacle to stablecoin use. Governments worldwide are debating on how to regulate stablecoins. The main questions revolve around who issues them, their reserve requirements and preventing money laundering. To me the last point is very important as it determines how centralised stablecoins will become. This may also be the biggest gateway for governments to make massive footholds of control in crypto.
The other challenge is the trust factor or the collateralisation peg. Fiat backed stablecoins are only as good as the reserve backing them. One example is the scrutiny around the reserves backing USDT as there are beliefs that it is not fully backed 1 as to 1 to the U.S dollar by reserves. This creates market anxiety. Also, the multiple collapse of algorithmic stablecoins has also damaged this trust factor. With the addition of recent algorithmic stablecoin depeggings, this type of stablecoins is losing trust and is moving towards extinction. An example is the collapse of UST (TerraUSD) in May 2022 that wiped millions in value.
Lastly, coins like USDC and Tether are issued and controlled by a single entity. This creates a point of failure and runs as a counter to the decentralised ethos. This degree of centralisation means that the government can shut down the company or freeze your assets. This is one of the reasons why I always say that, stablecoins are not real cryptocurrencies.
Final thoughts and conclusion
Stablecoins are very crucial as they solve cryptocurrency’s volatility problems. They also power the current cryptocurrency economy and have immense potential for global payments and mainstream adoption. Unlike other cryptocurrencies, stablecoins do not have that get rich quick allure, however, they are more revolutionary in terms of crypto adoption. Unlike other forms of crypto, they are practical, functional and a necessary foundation upon which the future of finance is built. While there are many challenges, the future journey of stablecoins will be shaped by innovation and regulation.
My Affiliate links
For crypto trading I use Okx and Kucoin:
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For forex trading I use justmarkets and FBS
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For synthetics trading 24/7 markets I use deriv and Weltrade
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References
Forbes - "What Is A Stablecoin?" https://www.forbes.com/advisor/investing/cryptocurrency/what-is-a-stablecoin/
CoinDesk - "The State of Stablecoins in 2023" https://www.coindesk.com/learn/the-state-of-stablecoins-in-2023-a-beginners-guide/
Circle (Issuer of USDC) - "Use Cases" https://www.circle.com/en/use-cases
The World Bank - "Remittances Remain Resilient but are Slowing" https://www.worldbank.org/en/news/press-release/2022/11/30/remittances-remain-resilient-but-are-slowing
The Federal Reserve - "Money and Payments: The U.S. Dollar in the Age of Digital Transformation" https://www.federalreserve.gov/publications/files/money-and-payments-20220120.pdf
European Commission - MiCA Framework https://finance.ec.europa.eu/publications/markets-crypto-assets-regulation-mica_en
