Nowadays, it is an established fact: cryptocurrencies are volatile. Even Vitalik Buterin, the founder of Etherium cryptocurrency, has said that cryptocurrencies are not the best place to keep your life savings. This is because cryptocurrencies, as Vitalik describes them, are too “hyper-volatile:” the prices shift so drastically that there is no guarantee if the prices would increase or, in the worst case, suddenly hit near-zero in no time. With this, he said, keeping your wealth is better left to traditional assets instead.
The Emergence of the Need for Stability
Due to its hyper-volatile nature, cryptocurrency trading has become a very wild ride for investors and the risks have become higher than ever. As a result, investors are either very lucky or very unfortunate with their investments.
Undoubtedly, the cryptoeconomy is massive, having trillions of dollars of worth, which is even expected to surpass the worth of the US economy in two years time.
However this trillion-dollar ecosystem, despite being the Goliath that it is, ironically still is in the verge of disappearing in a blink of an eye. Even Bitcoin itself, the very foundation of the cryptoeconomy, still has the risk of hitting zero without notice, perhaps even without a probable cause.
Thankfully, no such events have happened just yet, although the crypto space has been facing quite a share of bad news since the beginning of this year. One such notable news was the sudden loss of $100 billion dollars in the cryptocurrency market in just 24 hours, back in February.
Events such as this have investors wanting a bit more stability in the market, which led to the development of various ICOs that aim to resolve this drastic price-swing issues with cryptocurrency. This brought forth the concept of asset-backed ICOs and, of course, the crypto trading platforms and wallets that allow its holders to avoid the volatility of cryptocurrencies by allowing them to trade between other values such as fiat, gold and other assets.
This is why when a new type of asset-backed cryptocurrency, the stablecoin, has emerged in the market, which has the unique property of being pegged directly to specific fiat currencies, investors and enthusiasts alike have gone crazy with what just might be the key to the crypto worlds hyper-volatility dilemma.
The Dollar, Tokenized—The Stablecoin Feature
One of the very reasons why cryptocurrencies are volatile is because their values are dependent on supply and demand, in contrast to the traditional fiat currency which the total value in circulation is backed up by gold standard. Since the volume of trade in cryptocurrencies are drastically variable, this causes their prices to rise and fall at the same drastic rate with little to no anchorage, control and regulation, which leads to unpredictable price drops or overinflation.
The concept behind stablecoins is that they are resistant to such drastic price swings by means of automated regulation or being asset-backed. These two means of stabilizing coin value denotes the two types of stablecoins in existence, namely algorithmic and reserve-backed.
Stability by Mathematics
Algorithmic stablecoins are stabilized by means of software rules that controls the supply of coins in circulation relative to the current demand. In this way, price manipulation and fluctuation can be minimized (or even eradicated) since the value of the coin remains either the same or of minimal change. In short, as the demands rise, the system also increases the supply of algorithmic coins in circulation and conversely, the system finds a way to decrease the supply when the demand drops. Furthermore, the value of the algorithmic coins will be pegged to a certain fiat currency such as USD. This technology, although promising, still is under development and the concepts of this project remains theoretical to this day.
Stability by Standard Value
Reserve-backed stablecoins are the type of stablecoins that are currently widely used in the market. As compared to algorithm coins, reserve-backed coins have a more direct approach to being on-par with fiat value since they are backed up by fiat itself in such a way that fiat is backed by the gold standard. Stablecoins such as Tether and UScoin have their coins pegged with USD with a 1:1 ratio. This means that wallet holders require to trade a dollar for a coin. The dollars will then remain in the reserve until another coin exchange occurs. This ensures that the fiat currency value and cryptocurrency value will always remain the same—a direct tokenization of fiat, if you will.
A New Trading and Liquidity Option for Traders
As of now, there are over 57 existing stablecoins in the market in which approximately 22 are active and around 50 projects are currently in development around the world.
The emergence of stablecoins has enabled crypto trading platforms, most notably Bitfinex, to give investors a more stable and less-confusing option for trading, and perhaps a more trustworthy option to keep digital assets. Furthermore, this opens the door for cryptocurrency neophytes for them to know and experience the basics of crypto without having to diving into the risky and convoluted cryptocurrency market right away.
Although critics and skeptics point out stablecoin’s problems when it comes to scalability and liquidity as well as other weaknesses due to it being more challengingly structured than the average crypto, many supporters and enthusiasts still believe that the blueprint of stablecoin may become the trading standard that would resolve the hyper-volatility dilemma as well as the bridge that the fiat and crypto economy needs.