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What is a Stable Coin?

What is a Stable Coin

A ”stable coin” is a cryptocurrency that holds a stable value. The coin gets pegged to another stable asset such as gold or the U.S. dollar for example. Unlike our traditional stable assets, a stable coin is global and not tied to a central bank.

Why do we need Stable Coins?

Cryptocurrencies are global currencies, but coins like ether and bitcoin are highly volatile. During 2017 the price of bitcoin went up from $1,000 to $20,000, only to fall almost all the way back in 2018. There are now over 2000 different cryptocurrencies, and on any given day any of the coins can increase or decrease 10-20% in value. It is not sustainable, and investors and users need more stability and safety in the market. Besides, it makes daily transactions very inconvenient since the price can fluctuate a lot during a transaction.

Imagine that you pay $20 for lunch today, and tomorrow the same amount would be worth $25 because the value of your coin went up. Consumers cannot handle that kind of volatility. Therefore, stable coins can become the catalyst of driving the new wave of adoption to cryptocurrencies.

You might be thinking, why can we not just use fiat money instead of creating fiat-backed cryptocurrencies? Well, in the crypto world, it is not easy to circulate dollars because of regulations and restrictions. It does not quite work in a world of decentralised currencies. Therefore, by mimicking the U.S. dollar, an investor can sell its bitcoin for cash on an exchange that cannot deal in U.S. dollar.

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What is a Stable coin?

The ideal stable cryptocurrency should have a few different traits such as price stability, scalability, privacy and decentralisation. However, that is not enough. To spur wider adoption of any stable coin it needs to be simple to use, easy to integrate for partners and have the ability for an exchange to work with. The key feature is stability though. For the short-term when it comes to transaction and for the long-term stability is important for holding the currency.

Many cryptocurrencies are working to solve the problem, and now there are over 50 different stable coin projects under development. Each stable coin is unique, but they generally work in the same way. They hold collateral of some type and manage the supply to help incentivise the market to trade the coin at a stable value. When studied they can seem quite complex. In reality, a stable coin is a coin meant to hold a stable value.

The stable coins have, broadly speaking, two different categories. According to their stability mechanism, they can be asset-backed or have an algorithmic mechanism. We have already discussed the asset-backed type. They are pegged to an asset such as Euro or USD for example, but anything stable could back them. The stable coins hold the one-for-one ratio of what they are pegged too. For example, Tether is “tokenised” dollars and therefore holds one USD for every issued token. It means that for every token they issue they need to have one USD in their bank account. Because at any given moment, a token holder can exchange their token for a real USD.

In contrast, algorithmic stable coins employ a set of rules in their code that aim to match the supply of the token with the demand. Although from an engineering perspective asset-backed coins are easier to employ, algorithmic stable coins possess several advantages, such as better scalability, stronger network adoption incentives, and the ability to earn profits on the creation of the stable coins.

All of them have advantages and disadvantages but let us explore some of the most popular ones. In the top 50 cryptocurrencies, there are five stable coins. Namely: Tether (USDT), TrueUSD (TUSD), USD Coin (USDC), Paxos Standard Token (PAX) and Gemini Dollar (GUSD).

The most famous stable coin is Tether (USDT). It is a blockchain based asset and meant to hold the value of $1. It is a price-stable coin that is equal to the U.S. dollar. In the Tether Proof of Reserves system, anyone can check the amount of USDT in circulations on the Bitcoin blockchain via the tools provided at Omnichest.info. While the corresponding total amount of USD held reserves is proved by publishing the bank balance and undergoing periodic audits by professionals. USDT dropped to $0,92 at some point which should not happen. They do not let anyone check that they have stored a dollar amount equal to the token supply. Therefore, some argue that Tether is not in reality backed by USD.

TrueUSD (TUSD) is a blockchain-based stablecoin also pegged to the value of USD. TUSD on the other hand, U.S Dollars are held in the bank accounts of multiple trust companies that have signed escrow agreements, rather than in a bank account controlled by a single company. The contents of said bank accounts are published every day and are subject to monthly audits.

The main part to look out for is that the stable coin is transparent, that you can see that the backing is real.

The future and challenges for stable coins

Garrick Hileman is the head of research at Blockchain, and author of the recent stable coin report. He stated that the masses are watching the crypto market but are not entering because of the volatility. Stable coins are the solution.

“For millions of individuals, tens of millions in our view, as well as institutions, the volatility of crypto assets that we saw last year is keeping some people’s on the sidelines of the cryptocurrency movement. Stable coins can address that and enable some use cases that bitcoin or ether or other more volatile cryptocurrencies are suboptimal for – things like insurance.”

However, one of the biggest challenges for stable coins are scaling. It is difficult for reserve-backed stable coins to reach a level where liquidity is deep enough to support interesting applications of the technology. Backers will have to invest millions or even billions in each coin. It could potentially create a cap on how fast a stable coin can grow. When we see projects that have use cases for billions of people it can be a problem if it is difficult to scale.

Another potential problem is the regulation. Central banks may be quicker to act on stable coins than there were with cryptocurrencies because the stable coins are somewhat related to the fiat. Since the innovation of stable coins is fairly new, there are some technical challenges as well. Many of the current stable coins may not be perfect but over 50 projects are under development, and many more may come in 2019.

Regarding the future of stable coins, they can indeed drive adoption. The potential for stable coins is huge, in everything from crypto insurance to lending and savings means entrepreneurs also hope there can be room in the market for many successful, stable coins.

Imagine a charity. Today, when you give money to a charity, you do not know what happens to your money. If you send the money to aid a project on the other side of the planet, it may take a lot for the time for the money to arrive and the bank fees may be high as well. If you send a stable coin instead, you can track the whole process since it is decentralised. It will take a few hours which means the money will arrive on time. Lastly, you send a stable coin; the same value will arrive with minimal fees.

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Ledger Nano S - The secure hardware wallet