12.08.2020
Stablecoin concept

The unstable concept of Stablecoins: how it works and how it doesn’t

What immediately springs to mind when someone mentions Bitcoin to you? For the majority of people (who are yet unfamiliar with blockchain), it’s the mysterious Darknets where you buy drugs and sponsor all sorts of seedy mercenaries to start armed conflicts in the Middle East and blow up puppies and kittens on Xmas (“it was raining cats and dogs that day”).

Surprisingly, after years of massive adoption of the blockchain technology by the most famous and reputable companies around, when you talk to people new to crypto, the best you can hope for is a crooked smile and a dirty look. Where is Clark Kent when you need (insert a gender-neutral pronoun)? 

Why do I even need them? 

You may be thinking “What’s the purpose of stablecoins anyway? I’ll just get one coin and HODL forever untuil they’re worth 250 000”. That may very well be true. Or not. 

Someone wise said about statistical analysis: “Probability is nonsense. The chances of any event happening are 50/50. It’s either going to happen or it’s not.” So there you have it. You can bank half of your fortune on Bitcoins with a 50% chance of losing – or try something reliable. It’s your choice but betting all on one is for fools or geniuses, and it’s really hard to tell the difference these days. 

The definition of a stablecoin 

What’s a stablecoin? Stablecoins are supposed to be just that. A currency that has a stable volatility rate. Why does that matter? Bitcoin can fluctuate wildly in price, and that is why trade is difficult. Gold’s volatility rate is just over 1.2%. Since Tether a well-known stablecoin is tied to USD, its volatility is much less than that of cryptocurrencies, which are still a speculative currency. 

In theory, that is a good solution. On a very basic level, It’s much more comfortable to be trading coins that are not going to cost zero tomorrow. USD probably won’t, and Tether is backed by USD, ahem, kind of, read the case study below. 

So are stablecoins the salvation? They certainly have their flaws. For one, you won’t make a 100% ROI on them. Are they better than the previous versions in some ways? Certainly. What happens when you take the best parts of all coins and combine them? Don’t get us started. 

Stablecoin

FAQ

Is it a problem that stablecoins are not decentralized? 

If issuers create stablecoins, and not just anyone can create them, there is no equality of opportunity. That also makes them no different from banks, which fail in soul-wrenching ways all the time

Stablecoin analysis: can stablecoins kill the Dollar? 

While it seems that crypto (or digital money) taking over the dollar is a remarkable idea, there are multiple issues with digital money. First, it’s digital. What happens when someone turns the electricity off? Second, before stablecoin design can be implemented on the same scale, they need to be regulated. Which is a mastodon task. Then cyberattack risks would need to be taken into account. And so on. 

First, there are serious technical and operational challenges that would need to be overcome, such as the risk of creating a global target for cyberattacks or a ready means of money laundering. — Federal Reserve Governor Lael Brainard

In order for stablecoins (or even crypto) to take over the US Dollar they would have to be terrorist-free, cyber-attack-free, have no bugs or malicious code whatsoever (and remember that stablecoins are a relatively new concept), and be flawlessly regulated and taxed. Thus the answer it – it’s possible but it’s not happening anytime soon. 

Stablecoin list 

Here is a list of the most popular stablecoins in case you’re intrigued: 

  • Tether
  • TrueUSD
  • USD Coin 
  • Dai 
  • Paxos Standard 
  • EOSDT
  • Gemini Dollar 
  • Digix 
  • NeutralDollar
  • USDCoin
  • USDx
  • WBTC
  • BitUSD
  • Binance GBP StableCoin 
  • Reserve
  • Stasis EURO

Stablecoin Interest

If you’re not sure about trading but you still want to make money you can find a platform that allows you to deposit your stablecoins (such as Dai that you have bought for USD) and get passive income. Rates will obviously vary but you can easily get 7-10% APR or even something in the late twenties if you really look. 

Stablecoin ATMs

Yup. The future is actually here. Bitcoin ATMs are a thing now (take into account KYC and AML). And so are Stablecoins ATMs. If you’re going to Canada, don’t forget to get some maple syrup on the way back. We’re telling you, without it your life is incomplete. 

Can I create Stablecoins?

The Komodo multichain blockchain platform is one very attractive way of building stablecoins. Komodo’s Antara Framework allows users to create completely independent customized blockchains that can become one with the Bitcoin network. Pegging programs to prices and currencies allows is possible using the new features (for which coding experience is a definite plus – warning). Atomic swaps, real-world price tracking, and smart contracts, in general, make the impossible possible:

If you wanted to create a chain, you could do that right now, alone at your computer, without any external support, without any funds — without anything — and you can just like spin up your own blockchain. This blockchain would literally inherit all of Komodo’s technologies and features. — Komodo CTO Kadan Stadelmann

Is stablecoin backed by gold? 

One example is Tether’s stablecoin backed by gold called XAUT that gets you one troy ounce of gold kept in a Swiss vault that the company maintains. Here’s more

Stablecoin European stance

The EU is quite cautious about stablecoins. The dangers of cyberattacks we mentioned. The regulation concerns, energy consumption, and a plethora of other issues all mean the EU insists Europe will not want stablecoins anywhere near them until issues are all addressed.

Are Stablecoin Futures a thing? 

You can find Tether futures on Bitfinex as of 3 days ago by following this link (beware of leverage and trade responsibly!). 

Can I do stablecoin mining? 

Without a doubt! Staking (lending) stablecoins is a profitable business, and despite price stability there’s still money to be made here. Check out the Kowala (kUSD) project.

Is there a stablecoin Hardware Wallet? 

We’d say it’s a must for you to get a Tether wallet. We’re also for subdermal wallets. This one is not subdermal but if we could make it subdermal we would. 

Stablecoins’ advantages over Bitcoin 

Stablecoins are protected from risks we covered in our previous articles (market risks, etc), which have to do with market volatility. That makes them more reliable – but with compromises on other advantages that Bitcoin and other cryptos have. 

Is there a problem with Bitcoin?

Dollar

Indeed, there was part of Bitcoin’s history that was associated with Silk Road and the fact that it doesn’t discriminate one user from another and gives all equal access privileges probably means someone uses the money for something unseemly. Just like some people use USD for something unseemly, but that doesn’t mean there’s something sinful about having dollars. So why does that logic work with Bitcoins? 

After the abolition of the gold standard by Nixon, dollars aren’t tied to physical assets either. Some say Bitcoins (or crypto in general) are less reliable than the dollar, which everyone knows and loves, and maybe somewhat suspicious. But is the USD more reliable? What happens when the US government keeps printing money? It starts to become worth less. 

The point is that printing money is exactly what the Federal Reserve does every single day and every other Central Bank for that matter. Without restraint, they can and do print money.

If we take a modest measure of the US money supply (M2 – so physical money plus short term deposits) it has doubled since 2008 during which period US GDP grew only 35%. How has that happened? Well, it was basically created out of thin air by the Federal Reserve. — Listed Reserve

The halving mechanism built-in into Bitcoin by default makes sure that its value keeps going up. Not down. And it works – as shown by the evidence of previous halvings. Is the Dollar becoming more popular? Not really. In fact, it’s less than a thirtieth than what it was worth in 1960. 

Power of 1$

What’s the real problem with Bitcoin?

So what’s the actual problem with Bitcoin and why are people so resistant to using it? Critics will mention: 

  • scalability issues (which are literally being solved at the time of writing);
  • security issues,  which are less problematic than the banks have by several orders of magnitude;
  • and the issue of volatility. 

Now, you can easily see how having 1 Bitcoin that is worth $20 000 today and $8 000 tomorrow is a problem. There are all sorts of risk management strategies, but essentially it all comes down to having a speculative market. 

This is why stablecoin algorithms were created. Essentially, this a new version of currency that tries to solve the problems the previous versions had. That means that a stablecoin is backed by physical assets – or something of the sort. 

For example, a stablecoin may be tied to gold. For every coin you have, you can exchange it for a gram of gold. Just like in the good old times when the government actually valued dollars rather than just seeing them as paper – which is now only valid as far the government is happy to accept it as means of payment for goods and services. For now. 

Case study: Tether

So stablecoins are basically just supposed to stable. That’s a stablecoin’s foundational principle. One stablecoin you probably are very familiar with is Tether. Despite a sort of controversial history (whose isn’t?), Tether is quite popular today. What do we mean by that? 

Tether

Tether was originally designed to be worth its weight in dollars. Literally. One Tether was supposed to be worth one USD. However, after a while and a few contractual nuances later Tether’s lawyers confessed that they didn’t, in fact, have as many dollars in reserve as they claimed and instead of having a dollar in cash or cash equivalent there were less than three-quarters of that amount in the vault. For all their coins they could provide only 0.74 of the amount in USD. 

A couple of lawsuits later (one because Tether failed to provide results of an audit that proved what they were saying was true) – and there are still questions. 

The company couldn’t find enough USD to ensure all customers’ withdrawals in 2017, for example. Tether was accused of creating “magic Tethers out of thin air”, price manipulation, failure to back up every Tether in USD. Long story short? Is Tether really backed by USD? They failed to provide an audit that would prove that. Well, there was one by a company called FSS who also stated that

The above confirmation of bank and tether balances should not be construed as the results of an audit and were not conducted in accordance with Generally Accepted Auditing Standards.

Stuart Hoegner, Tether’s general counsel, said: “The bottom line is an audit cannot be obtained. The big four firms are anathema to that level of risk. We’ve gone for what we think is the next best thing.”

However, despite all the controversy, the mechanism behind the stablecoin basis seems to work. If you track Tether’s price throughout time, it remained, well, stable. 

Tether Charts

Great job! So why are people so hesitant to adopt them? Partly because people are always skeptical about the new things: “Yeah, like that ridiculous automobile idea is going to work”. Also, some features of stablecoins are still problematic. They’re not borderless, decentralized, censorship-free, or many other things, like Bitcoin. Check out this awesome video for more: 

Problems with stablecoins 

How does stablecoin work? Stablecoins are not cryptocurrencies. They have one single point of failure, they are not censorship-resistant, open for everyone and comfortable with going from one geographic and jurisdictional territory to another. For example, Libra is a stablecoin. Stablecoins like Facebook’s Libra and JP Morgan Coin (a private blockchain) are not public. They have a central point of failure, which is a big problem. 

Libra is managed by centralized governance and has only a few validating nodes. JPM Coin is joked about in a stablecoin Forbes article: 

In which way has the new alleged JPMorgan crypto coin anything to do with blockchain/crypto? It is private not public, permissioned not permissionless, based on trusted authorities verifying transaction not trustless, centralized not decentralized. Calling it crypto is a joke. — Forbes 

Having a central point of failure is a problem for many reasons. First, if you have a stablecoin and it’s going to be backed by reserves in some vault, the government can seize or arrest it at any point it wants. 

Second, whoever is in charge can manipulate the value or dissolve the supply. 

Third, hackers can attack the vault – never mind robbers. In that sense, having a so-called fiat-based stablecoin goes against all the principles that make crypto great. And there are many questions as to whether they will be as effective. 

Co-founder of Ethereum and Founder of ConsenSys, Joe Lubin, describes Facebook’s Libracoin as ‘A centralized wolf in a decentralized sheep’s clothing. — Hackernoon

New and updated stablecoin business models

Algorithmic stablecoins

Because fiat-based stablecoins are problematic thanks to their vulnerability to attacks on a centralized point fo failure, the world is beginning to see the emergence of new types of stablecoins with different stablecoin blockchain design. 

Some of them are algorithmic, meaning they can adjust for changes in price by automatically printing more tokens (for example if a token is supposed to cost $1 and its starts costing $1.05 more tokens will be printed to make it cost $1) or, conversely, burning them. Dai (below) uses such mechanics to keep the price where it needs to be. 

Could Dai be the solution? It certainly combines the best of both worlds. As long as all these issues are addressed, there is a very clear potential for success. What’s more important, however, is that this is just one of the tools of a much greater mechanism: 

The software behind Dai is technologically complex and consists of over 1,000 lines of code, “which is a lot for crypto,” Dragonfly Capital’s Alex Pack says. It lays out rules for how new Dai are minted and how the system is maintained. For example, to create $100 worth of new Dai, users must pledge $150 of ether. — Forbes 

Crypto-based stablecoins

Even though there is much derision about the concept of stablecoins, creating a hybrid and backing a stablecoin with crypto is a remarkably interesting idea (if you’re a fan of the Underworld series).

One such example is an Ethereum ERC20 token Dai. There is no centralized authority like in JPM coin, no promise of data leaks and few elite managers in charge, like with Libra, and nowhere to strike to destroy Dai. 

Stablecoin benefits

But it has smart contracts, a stablecoin ethereum team that worked on them before Ethereum even existed, tradeability like all other tokens, and no fear of governmental shutdowns. It is in part an algorithmic token that uses complex mechanics to adjust its own price – and it’s still possible to make money on it. Dai is backed by ETH. 

 When Dai is worth above $1, mechanisms work to decrease the price. When Dai is worth below $1, mechanisms work to increase the price. The rational actors that take part in these mechanisms do so because they earn money anytime Dai is not perfectly worth $1.

A good example of the contemporary usage of the USDT stablecoin is Nominex, an exchange that doesn’t support deposits and withdrawals in fiat. You can find tokenomics, security measures, and 24/7 support by following the link above and see stablecoins in action for yourself. 

Finally 

We hope this complete guide to Stablecoins was useful (oh, last thing, remember, they are not to be stored in stables). If there’s anything we missed, let us know in the comments. Thanks and have a great day!

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