Bitcoin has plunged from a high of just about US$20,000 in December 2017 to as low as US$3,675. So it’s understandable that some cryptocurrency users could be trying to find more stability. With the longer term of Bitcoin and other cryptocurrencies uncertain, a possible new solution referred to as “stablecoins” has emerged. This cryptocurrency aims to carry its value better than others, which could offer investors more stability.
Cryptocurrencies are digital tokens that act as a sort of currency, effectively allowing people to perform transactions without a bank or intermediary. Most cryptocurrencies haven’t any intrinsic value and obtain their price from what others can pay. This, alongside price speculation from those hoping values, will rise, which has led to significant price volatility in cryptocurrencies.
Unlike other cryptocurrencies, stable coins aim to take care of their worth better by being redeemable for something else of tangible value, like regular fiat currencies like US dollars, or maybe gold.
The stable coins’ underlying asset (the price that investors expect it to trade at) would usually be deposited with a trusted bank. If people are confident, they will redeem these coins in exchange for said currency, in which the issuer has sufficient reserves for all coins in circulation. The worth of the stable coin shouldn’t fall below the underlying asset value.
The most widely used stablecoins are Tether, TrueUSD, and USD Coin, which bind their value to the US dollar. Tether experienced some short-term volatility, fluctuating between $0.989 and $0.95. TrueUSD has held stable, but USD Coin has had slight instability – though even its most significant drop remained within 1.8% of the dollar. Compared with other cryptocurrencies, then, stablecoins have remained stable.
But there’s nothing technical keeping the worth of stablecoins at a hard and fast value. If people lose confidence that the issuer has enough assets reserved to honour the quality of all coins if redeemed, it could lead to significant price variations. The worth could also rise if demand outstrips the supply of a stable currency.
Why are stable coins becoming popular?
The recent crash of Bitcoin and other cryptocurrencies, alongside inconsistent trading prices across exchanges, have influenced the perception that cryptocurrencies are unpredictable. The thought of a cryptocurrency with a hard and fast value has understandable, especially among those eager to make purchases with cryptocurrencies.
Cryptocurrency exchanges also are moving faraway from interacting with banking systems due to heightened regulatory interest and a spotlight in cryptocurrency operations. In some notable cases, exchanges have even had their funds frozen by banks. This has led some popular cryptocurrency exchanges not to allow transactions between cryptocurrencies and real money. So, to shop for on these exchanges, people need existing cryptocurrencies – making stablecoins a realistic option for starting.
Will computer algorithms maintain stability?
Seigniorage-based stablecoins are the newest development. These use computer algorithms to regulate the stablecoin’s availability by buying and selling it automatically supported real-time prices, ideally keeping the coin’s price stable. If rates rise, coins from reserves would be made available to shop for, which increases supply and reduces the price. If the worth falls, the algorithm can purchase back coins (using other cryptocurrencies held in reserves) to scale back the amount and increase the value.
But if supply increases too rapidly, the algorithm won’t have sufficient funds to shop for back enough coins to stabilize the worth. This might cause the worth to plummet, especially if people lose confidence within the coin issuer. However, this will also happen to regular fiat currencies, not just stablecoins, as currencies are only valuable if others will accept it – otherwise, it significantly loses worth.
Stablecoins might present an answer to short-term volatility, provided the currency backing its value remains stable in worth. But they won’t fix confidence losses, especially if the quality of the stablecoin’s reserved assets is questioned. If the power to redeem this currency is in danger, the stablecoin’s price will likely fall.
Seigniorage-based cryptocurrencies may handle limited volatility if they need enough reserves to regulate supply with algorithmic buying and selling. But this still requires people to hold or accept the coin willingly. Flash price crashes that occur when many a cryptocurrency is sold during a short time aren’t unprecedented, showing the critical potential for extreme volatility thanks to large transactions.
There’s also a significant premium for using stablecoins to get other cryptocurrencies. At the time of writing, it cost almost US$118 per unit more to shop for one Bitcoin using Tether than US dollars, despite both supposedly having an equivalent underlying value. If the market saw stablecoins as an answer to cryptocurrency volatility, the worth would be an equivalent because it is with cash.
While stablecoins might reduce the number of risk buyers see in cryptocurrency, primarily associated with price instability, it’s unlikely they’ll be used more generally.
Using stablecoins for day-to-day transactions has many challenges, especially if the system can’t make more coins available if demand increases. Stablecoins aren’t protected by the compensation schemes some cash bank accounts are, making it unlikely that most people will replace their cash accounts.