Stablecoin here, Stablecoin there…but What are Stablecoins?
08 / 08 / 2022
Discover all the details behind a stablecoin, its pros, cons and what makes it such a boom in the world of online payments and transactions. What makes the stablecoin different from other cryptocurrencies? What factors make it able to counteract the risks known from the usual cryptocurrencies? Take a closer look from one of our experts.
For a few weeks now, there have been plenty of post mortem articles on the reasons of the crash of Terra/Luna. Was it a flaw, was it an attack…speculation (again!!!) runs high.But let’s concentrate on what are stablecoins and the types of stablecoins.
Of course, we are not in an environment where someone has created stablecoins and given a definition that is abided to by all. Everyone, and their brothers/sisters, have their own vision and definition of the term. And since I’m no better than them, I do have mine. Let me explain it, and feel free to express your agreement or disagreement with it…
Stablecoins exist in the “crypto world” (i.e. more or less from Bitcoin “creation” onwards) and are assets managed by a DLT of some sort.
Before stablecoin’s first appearance, all the pre-existing cryptocurrencies (e.g. popular cryptocurrencies like Bitcoin, Ethereum, etc.) were all highly unstable (i.e. fluctuating in market value).
Stablecoins are in this regard a push-back, a counter-proposal to these existing cryptocurrencies. In mathematical terms, I would say that stablecoins are the logical negation (¬) of cryptocurrencies.
What are the reasons for this instability of cryptocurrencies?
There are two main instability factors:
- The fact that these cryptocurrencies are backed by nothing. There is no intrinsic value attached to them that could create a floor/minimal value (e.g., a $2 note signed by Andy Warhol can be worth a lot, but no less than the $2 bill it is written on).
- The supply and demand market valuation mechanism, just like in other market environments like (but not limited to) stock market and raw materials.
What actions can be taken to “logically negate” this?
Two classical ways are often seen in stablecoins, which are the counter actions of the above:
- Providing an intrinsic value to the asset by, for example:
a. Pegging the cryptoasset to a currency (making it a cryptocurrency that can be backed 1:1 by a commercial “fiat” currency, like escrowing dollars in a bank, or backed 1:1 by central fiat currency like CBDCs)
b. Pegging it to any other (physical or digital) asset like gold, stocks, securities, services, ownership of assets, etc. A good example is Worldline’s DaVinci Gold project, which created a stablecoin pegged to precious metals like physical pure gold like reserve assets.
- Controlling and mastering the supply and demand process. This is based on the fact that “predictable” trends in a market value are linked to certain “activities”. So, by mastering these “activities” one can, theoretically, master the trends of the market value to keep it flat/stable. Theory explains that:
a. Market value rises when the demand is higher than supply. So technically, increasing supply while demand is rising is a way to stop the market value rise. If the cryptoasset is not pegged to anything, then it is quite easy to create more cryptoassets and manage the rise. Although, if the cryptoasset has a “creation” cost, for instance, for each token you create you need to escrow 1€, it can become problematic.
b. Market value drops when the supply is higher than the demand. Here there is a lexical subtlety because it is not only the supply (i.e. the number of existing cryptoassets in circulation), but also the sale’s pressure. Removing stocks of cryptoassets will indeed mathematically make the per asset price increase, but it won’t stop people who want to sell stop selling. The proper way is the “buy back” of the cryptoassets by the sellers.
But then comes the question of “with what money” do you buy them back?
Of course, if you pegged your cryptoasset with a 1:1 escrow, you can purchase back your assets.
Another subtlety with these popular stablecoins is also the “environment” they’ve been created in.
Some are created in “public blockchains”, like some colored coins in Bitcoin, or many stablecoins in Ethereum. If those stablecoins are properly issued and guaranteed, there is an inherent risk of “operations” due to running on a public blockchain.
What if there is a bug? What if there is a major hack? What if there is a fork that doesn’t work with your model? What if transaction fees rocket high?
Others, like most CBDCs, or the Da Vinci Gold tokens, are created in “private blockchains” (i.e. a totally controlled infrastructure). If those stablecoins are properly issued and guaranteed, there is no more inherent risk of “operations” than any other software product.
What if there is a bug? We correct it in no time. What if there is a major hack? We own and run the code. No one else touches it and all the cybersecurity barriers are set to protect the infrastructure.
What if there is a fork that doesn’t work with your model? We own the code, the only modifications are the ones we put in place. What if transaction fees rocket high? We decide on the price, if any.
As depicted here, stablecoin groups many different instantiations and proposals. As always, none are inherently good or bad, it depends only on the objective of each project.
Worldline is mastering and managing all the main means of payment, current and new. To get more information on how to access digital currencies, leveraging existing ones or creating one to suit your own business needs, please contact us.
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