Stable Coins: An Emerging Asset Class
Blockchain has invaded every industry and has shown a clear, transparent, safe, fast and decentralized currency option to the world. We know it by cryptocurrency which is a new means of exchange- the digital cash. Bitcoin is the first of its kind of virtual currency. However, this cryptocurrency has a very serious drawback. Its value fluctuates on a daily basis and is not fixed.
People who invested in bitcoin became millionaires overnight, only to lose much of the money just a few weeks later. This is the reason why cryptocurrency market sank to alarmingly low levels with the digital assets at all time lows. It is completely unreliable- especially if you see it as a currency for goods and services that are used on a daily basis. The answer to this problem came with the emergence of a new asset class: Stable coin.
What is a Stable Coin?
Stable coin is a cryptocurrency whose price is fixed. Its value is pegged to a currency or an exchange-traded commodity (like precious metals or industrial metals) which are stable assets. It can be used globally for practical usage like paying for things every day. The currency is not tied to a central bank and has very low volatility. Therefore, stable coins are simple, stable, scalable and secure means of transaction.
Types of Stable Coins
There are four main types of stable coins:
Fiat-Collateralized Stable Coins
They are the most common type backed by the fiat currency like USD, EUR, GBP. As long as the value of the currency is stable, the stable coins value will not change. They are backed at 1:1 ratio i.e. 1 stable coin is equal to 1 unit of currency. Ex- Tether (USDT), TrueUSD (TUSD), LBXPeg, USDC, etc.
Commodity Collateralized Stable Coins
They are backed by interchangeable assets like gold, oil, real estate, and other precious metals. Most commonly gold is used as collateral. These tangible assets might appreciate in value over time and now even a common man can invest in these valuable assets through cryptocurrencies. Ex- Digix Gold (DGX) backed by gold. 1 DGX = 1 gram of gold. Tiberius Coin (TCX) backed by a combination of 7 precious metals. SwissRealCoin (SRC) backed by a portfolio of Swiss real estate.
Crypto-Collateralized Stable Coins
They are backed by other cryptocurrencies. These are over-collateralized to absorb price fluctuations in the collateral. These are much more decentralized, secure and transparent. They are more liquid so can be easily converted into their underlying asset. Ex- Dai whose face-value is pegged to USD and is actually backed by ETH.
Non-Collateralized Stable Coins
They are not backed by anything. The prices are controlled by managing the demand and supply of stable coins. If the demand increases, new stable coins are flown in the market to bring down the price. Vice versa is done if the demand decreases. This model is known as seignorage shares. Ex- Basis.
1). Fiat collateralized stable coins are centralized because they are run by a single entity. These are sometimes suspected that whether they have real backing or not. To bring in more trust, stable coins should go for regular audits from third parties. This will ensure transparency.
2). Another limitation with fiat backing is that they are constrained by the regulations that come with fiat currency. So the conversion process is also not very easy. They are less liquid in comparison to other cryptocurrencies. The commodity backed stable coins are also not very liquid. It also has the risk that the value of the underlying asset might crash.
3).Crypto-backed cryptocurrencies are more vulnerable to price instability. In case of a price crash, they are automatically liquidated into the underlying crypto asset which is no longer stable. They are complex and difficult to understand.
Therefore, each one of them has its own unique benefits and drawbacks. It will be too early to comment on their success and the emerging ones will have to experiment with the new concepts to determine what works and what doesn’t.
What we are witnessing recently is a ‘stablecoin invasion’. At present, 57 stable coins have been released or are in development phase globally. Paxos Standard (PAX) and Gemini Dollar (GUSD) are two USD-backed stable coins that have been approved and regulated by the New York State Department of Financial Services.
However, cryptocurrencies are in their nascent stage and particularly the stable coins. One can’t predict the future of blockchain exactly in this ever-changing world but one thing is for sure that stable coins have the potential of bringing the whole concept of cryptocurrencies to the mainstream.