In Search of Security - from Bitcoin to Stablecoin

One of the issues for the entrance of cryptocurrencies as a means of payment is that their value varies greatly. They are not secured with a certain asset, and that is why they cost as much as the others or as “the market” decides. On 11 December 2017, bitcoin cost USD 17,060.55. A year later, on 10 December 2018, it was exchanged for USD 3339.08. With such big fluctuations, it is not realistic the trade of items with constant and clear value to be done in bitcoins. In this case, the so-called “stablecoins” could be of help.

Stablecoins are cryptocurrencies whose value is constant or could undergo minor changes. Usually, this cryptocurrency is linked to a certain asset, with collateral. To some extent, they resemble fiat currencies that are in circulation. If they are associated with a particular asset, such as a bank deposit, the owner of the stablecoins can at any time request the exchange of their cryptocurrency for the real asset. If they become widely accepted, stablecoins could turn into a real opportunity not only to save money in a “hard” currency, but also to become a means of payment for consumer goods.

Some of the well-known stablecoins are Tether, TrueUSD, USD Coin. Currently, their value is kept constant against the background of the other cryptocurrencies that have high volatility. Standard cryptocurrencies are considered unpredictable. Their acceptance has led, in recent years, to the introduction of a number of regulations in the Western world. In some cases, banks are freezing funds on the cryptocurrency exchanges. As a result, these exchanges strive to avoid banking systems and, in some cases, introduce a limitation for transactions between cryptocurrencies and real money. Here, stablecoins can be useful again – to buy other cryptocurrencies.

The functioning models of stablecoins are different. One opportunity is a centralised company to hold assets in a bank account and to issue stablecoins that allow for the asset to be exchanged. This is the way, for example, in which Tether works, whose creators claim to have dollar collateral for each unit of the stablecoins in circulation. This, however, raises questions about the transparency of the currency creation and the extent to which the collateral is indeed available for all assets.

Another model is to create stablecoins that are secured with other cryptoassets. That’s what BitShares does. In this model, the asset supporting the stablecoins is a decentralised cryptoasset – for example, the Dai stablecoin is secured by the Eterium cryptocurrency with the help of a smart contract through the Ethereum platform. In this case, users do not need a third party to ask for the exchange of the stablecoin with its collateral. Here, the problem is that the collateral is an asset in a cryptocurrency that can significantly change its exchange rate. In case of a drastic fall in the value of the secured asset, the stablecoins may lose their collateral. Therefore, in most of the cases where this model is used, stablecoins are over-secured in order to be protected from acute price changes. Even that, however, does not provide 100% security in preserving their value.

The third stablecoin model is the closest to the way real-life currencies work and is called the Seigniorage Method. Through an algorithm, the supply of stablecoin on the market is expanded or shrunk, as do central banks with money in circulation. In this case, the stablecoins are secured by nothing but the expectation of preserving their value in the future. Various models have been used to expand and shrink money supply, the most popular of which is related to the use of issuance and redemption of bonds and shares in the respective stablecoin. This is what Basecoin does, for example.

Stablecoins can solve the problem of the volatility of the cryptocurrencies, but they still need to establish themselves and gain the trust of their users. One of the issues in this regard could be related to questioning the assets that secure the currency. Even with the Seigniorage model, in order to trade with a certain currency, there must be people willing to buy/sell it, that is, to trust it.

Stablecoins can be very helpful in making daily purchases. They can serve as a saving currency in countries with a volatile exchange rate of the national currency. Still, stablecoins will not easily become an alternative to deposits, because, while in many countries there is protection of bank savings up to a certain amount, such protection of the savings in stablecoins does not exist.

The rise of bitcoin was due to the desire of many to become bitcoin millionaires by buying low-priced cryptocurrencies and selling them at high prices. The trend for the past year, however, is a drop in the price of bitcoin and the cryptocurrencies as a whole. Will more and more cryptocurrency investors replace greed with a desire for security? The attitude towards stablecoins may reveal whether such a trend exists.