stablecoins

The Rise of Stablecoins

Bitcoin dominance in the crypto market is unrivalled. In the past two years, it has reached 66% of the entire cryptocurrency market. But in terms of daily trading volumes, Bitcoin has an unprecedented and somewhat surprising competitor: stablecoins.

The leading stablecoin, Tether, has a trading volume of about $20 billion per day, which is slightly above that of Bitcoin, according to CoinMarketCap data, the most reliable source for such information. Tether’s volume surpassed that of Bitcoin’s for the first time in April and has remained on a high level ever since then.

The success of Tether, which is pegged to the US dollar, is attracting a great deal of interest from investors, speculators and regulators towards stablecoins in general. What are the stablecoins’ advantages, making them even more attractive than Bitcoin? And how are they integrated into the rest of the crypto market? We will address all of these questions in this article, but first, let’s go through a short recap of what stablecoins are.

A stablecoin is an instrument for combatting the excessive volatility of the crypto market. Holders of stablecoins stay relatively protected from the extreme unpredictability typical of this market, while at the same time gaining exposure to the sector.

Stablecoins have low volatility thanks to a reserve mechanism. Most of the stablecoins are pegged to relatively solid assets with low volatility, at least in the short- and medium- term. The stablecoins’ issuers usually promise to keep a reserve of these base assets, mostly fiat currencies, like the US dollar or others, or precious metals like gold. This mechanism turns the stablecoins into a blockchain-based synthetic version of a “real world” asset. Another type of stablecoins are those which are pegged to crypto assets, and try to achieve stability through the use of “smart contracts,” but they are much less popular than the “real world” type.

Stablecoins are useful as a hedge for investments as well as a means of payment for goods and services, or for salaries and rents as well as for money transfers. Therefore, the search to secure crypto investments against the erratic market is a prime reason for using a stablecoin.

Another route that leads to the usage of stablecoins is as a bypass to the complications of on-ramp and off-ramp for crypto trading. Stablecoins can function as a gateway and allow easier transfer of money between Bitcoin and dollar, for example. Generally, they are an effective tool for overcoming the obstacles posed by the traditional financial system and regulators. As more blockchain businesses are established, there is an increasing demand for keeping and using fiat money for their routine operations, such as paying salaries, for example. It seems that stablecoins give the best solutions for these needs at the moment, and this is leading to their popularity. While the immediate usability of stablecoins is quite obvious, they may also have a role in introducing blockchain-based services to mainstream users, thanks to their fairly reasonable prices. This is despite the allegations that some of the people who use stablecoins don’t really understand these assets’ synthetic nature, and believe that they have a direct possession of the reserved asset.

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As mentioned earlier, Tether is currently the prominent stablecoin, with a huge lead over its competitors. It is a centralised currency, issued by a private Hong Kong-based company, which also owns the Bitfinex crypto exchange. Tether market cap is around $4 billion. Earlier this year, Tether raised a billion dollars in a huge ICO, through the Bitfinex exchange’s native token, LEO. Tether’s daily trading volume is four times as much as its market cap, most probably because of the intense activity of trade bots, just like in any popular asset. Facts that casts shadows over Tether are allegations by the New York Attorney General that its currency was not backed by a full reserve of dollars, as it had promised. There are allegations that Bitfinex covered the loss of $850 million from the funds that were supposed to back up Tether, but it has denied this. The investigation has followed demands that Tether publish a full audit of its dollar holdings, but it has failed to do this.

The second largest stablecoin is the USD Coin, which has a market cap well below that of Tether. It is run by the Goldman Sachs-backed startup Circle and the San Francisco-based Coinbase exchange. As is clear from its name, the USD Coin is also pegged to the dollar, and has a market cap of only $450 million. The next-in-line stablecoins are Paxos Standard and the Gemini Dollar. eToroX is in the process of suggesting stablecoins pegged to other currencies, such as the Turkish Lira (TRYX), Polish Zloty (PLNX), South African Rand (ZARX), Hong Kong Dollar (HKDX), and Singapore Dollar (SGDX). Overall, there are about 70 stablecoins currently trading.

Regulators are aware of the stablecoins’ boom and are curious, yet suspicious of it. They seem to realize that as compared to Bitcoin, which might be challenging for the mainstream market, a cryptocurrency which is backed by a known currency, has the potential to gain popularity much faster. Facebook’s Libra project, that was revealed in June, made this option even more feasible. Libra is supposed to be global money that is managed through blockchain technology and is backed by a basket of assets that are supposed to promise its stability. The Facebook initiative compelled the regulators to urgently respond.

In October, the Financial Stability Board, an international body that monitors the global financial system, provided the leaders of the largest economies in the world (the G20) with a risk assessment of stablecoins. While the report doesn’t see Bitcoin as a risk to global financial stability at the moment, it pointed a finger at stablecoins as representing such a danger. The report declares that “the introduction of ‘global stablecoins’ could pose a host of challenges to the regulatory community, not least because they have the potential to become systemically important, including through the substitution of domestic currencies. Global stablecoins might offer a vehicle for cross-border payments and remittances for a large number of users”.

Bank of Japan Governor Haruhiko Kuroda said that: “Some emerging countries have concerns regarding what could happen if stablecoins backed by a huge customer base become widely used globally. But this is not just a problem for emerging economies. It could have a broader impact on monetary policy and financial system stability.”

In November, The US Federal Reserve System devoted a long discussion to stablecoins in its biannual review of financial stability. The Fed warned that while the innovation of financial products could serve as a new medium of exchange, the financial system could face “potentially severe consequences” if a broad-based stablecoin is poorly designed or regulated. It also gave credit to the potential success of stablecoins, saying that: “The possibility for a stablecoin payment network to quickly achieve global scale introduces important challenges and risks related to financial stability, monetary policy, safeguards against money laundering and terrorist financing, and consumer and investor protection.”

Bank of England Governor Mark Carney has adopted a different position. At a speech to bankers from around the world, he explained why he expects a shift in global markets after years of dominance of the dollar as the world reserve currency. Carney predicted that a new digital currency could transform and influence these markets. While he has left the question open about the properties of this new currency, his description was similar to that of a stablecoin, probably one that is created from a basket of a few currencies and managed by a central bank.

* The information above does not constitute any form of financial or investment advice and should not be relied upon. Investing in Digital Assets carries risk. For more information please see our risk warning.

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