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Stablecoins: What’s next for this accelerating asset class?

June 22, 2020
Stablecoins are displaying astronomical growth, with a new study showing that on-chain activity for these digital assets has increased 800% in the last 12 months[1]. The most liquid are now the most used: ERC20 tokens have pushed Ethereum blockchain daily transactions to their highest since the frothy market days of July 2019[2]. Now — what is a stablecoin and why are we seeing such rapid growth?

The stablecoin was created to combat the high volatility of cryptocurrencies. It stabilizes its price by pegging its value to another asset, which gives it the stability of a fiat currency whilst retaining the efficiencies of a cryptocurrency. Stable coins can be divided into 3 major classes.

Fiat-collateralized

A stablecoin can be pegged against a fiat currency such as the US dollar or the Euro. Some stable coins hold their fiat peg in reserve on a one-to-one basis. The largest stablecoins by market cap fall into this category (examples include: Tether USDT, The Centre’s USDC, Trust Token TUSD and Paxos PAX). The backing can also be a mixture of fiat and stable commodities. Some stablecoins are also entirely pegged to these stable commodities, such as oil or gold (some people view this as an additional category; commodity-collateralized).

Crypto-collateralized

Stablecoins backed by a basket of cryptocurrencies provide price stability by over-collateralizing to absorb market volatility, i.e. by holding 1.5 times the issued value of stablecoin. The most prolific of these stablecoins is MakerDAO’s DAI.

Non-collateralized

As the title suggests, these stablecoins are not backed, but instead rely on an algorithm to increase or decrease its supply via smart contracts to hold its value steady. Ampleforth’s Ample and the Basis protocol are examples of this, although the latter was recently shut down due to regulatory hurdles.

Sub-classes

Some stablecoins are a combination of collateralization types. Each of the aforementioned classes becomes more decentralized as you move down the list. Starting from fiat collateralized and crypto collateralized that may have a single issuer to stablecoins that are auto-executed smart contracts on a fully decentralized platform, they have many forms of existing.

For now, the crypto markets are dominated by fiat collateralized stablecoins, with USDT leading the charge with a market cap of US$8.3 billion and USDC a trailing second at US$706.5 million, as of May 10, 2020. USDT alone is the 4th largest cryptocurrency by market cap, behind bitcoin (BTC), ethereum (ETH), and XRP. Tether has, however, had its share of controversy with a pending class action[3] grounded on the alleged minting of USDT unbacked by USD for the purpose of manipulating the price of BTC; highlighting one of the main issues with stablecoins — counterparty credit risk. Interestingly enough, this has not impacted its dominant position in the market.

Despite their name, stablecoins are not always traded one-to-one with their fiat-backed equivalent, with variance of +/- 5% seen with some traders taking advantage of the arbitrage between various stablecoins.

The largest use of stablecoins and the reason behind their initial creation is two-fold: they are a stable digital store of value for traders and an efficient low-cost way of moving this value. Traders need the ability to exit trades at the right time to protect themselves from the volatility of the crypto market, but need to do this through a medium that they can put to work quickly again without the associated time lost and high charges of potentially having to move fiat through traditional banking channels.

Beyond the realms of crypto trading, stablecoins have the potential to be used by businesses for not only internal treasury management but also daily business transactions to take advantage of the high speed and minimal cost of transferring value, and potentially opening up a wide swathe of unbanked individuals and businesses or those whose local currency is inherently unstable.

The dominance of the fiat collateralized stablecoins indicates that the market still enjoys the “comfort” of being linked to traditional regulated financial markets, and regulators are working their way into the space with significant variation between countries, and in some cases the push towards Central Bank Digital Currencies (CBDC)[4].

Regulation is required as the use of stablecoins as a relatively risk free on-ramp to the cryptocurrency markets presents a number of regulatory issues associated with money laundering, money services business regulation, investment and trading, banking and specific virtual currency regulation[5].

In our view, this regulation is essential to give professional traders and the wider business market the comfort to take advantage of the efficiencies provided by cryptocurrencies in the form of stablecoins and we are watching this space along with the developments of CBDC’s very closely.

To start to trade with USDC, visit www.equos.io

[1] BitcoinKE Article 23 April, 2020 “ StableCoins See 800% Growth YoY with USDT Tether Dominating 2020 Charts, Latest Study Shows: https://bitcoinke.io/2020/04/800-percent-growth-in-stablecoins/

[2] Coindesk Article 4 May, 2020 “Stablecoins Push Ethereum’s Transaction Count to Highest Since July 2019: https://www.coindesk.com/stablecoins-push-ethereums-transaction-count-to-highest-since-july-2019

[3] https://www.scribd.com/document/442403565/SDNY-Complaint#fullscreen&from_embed

[4] Diginex Article, March 16, 2020: Will 2020 be the year of the Central Bank Digital Currency?: https://www.diginex.com/insights/will-2020-be-the-year-of-the-central-bank-digital-currency/

[5] Clifford Chance Report September, 2019: Stablecoins: A global Overview of Regulatory Requirements in Asia Pacific, Europe, the UAE and the US: https://www.cliffordchance.com/content/dam/cliffordchance/briefings/2019/09/stablecoins-a-global-overview-of-regulatory-requirements-in-asia-pacific-europe-the-uae-and-the-us.pdf

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