Stablecoins have rapidly grown in popularity and volume recently.
Stablecoins are cryptocurrencies that are designed to maintain a stable price. This stability is in reference to another asset – like the US Dollar or the price of gold.
The types of asset that are used as the base for stablecoins include:
- Fiat currencies – such as USD (most popular currently), EUR or CHF.
- Commodities – such as gold or oil.
- Other cryptocurrencies (such as bitcoin or ethereum).
There are currently two subcategories of stablecoin:
- Asset-redeemable: these coins are redeemable for a predefined amount of USD, gold or other asset.
- Non-asset-redeemable: also called seigniorage-style – the price of these coins is stabilized by creating or destroying coins (if the price of the coin is falling or increasing respectively). This is designed to be similar to how a central bank keeps the price of fiat currencies (such as USD or EUR) stable.
Examples of asset-redeemable coins include:
- Fiat-currency-redeemable coins – such as TrueUSD.
- Commodity-backed coins – such as Gold Tokens.
Central banks are also looking at starting to issue asset-backed cryptocurrencies in the form of Central Bank Digital Currencies (CBDCs) – for example China is reportedly looking at the digital yuan and Japan is looking at the digital yen. These may or may not be asset-redeemable.
Examples of non-asset-backed (or seigniorage-style) stablecoins include:
- MakerDao – the coins are called Dai and 1 Dai is stabilized at 1 USD. The coins are backed by Ether, and use smart contracts to maintain the peg to the USD.
- Basecoin – Basecoins are also pegged at USD 1 each. The “money supply” (as in number of coins) is increased or decreased, by allowing coin holders to buy bonds when the price of Basecoins is falling, and sell bonds when it is increasing.
- Libra – the Facebook-initiated project to issue coins pegged to individual currencies (such as USD, EUR and GBP) and coins pegged to a basket of currencies.
Risks and future growth
Some major risks with stablecoins are the risks of fraud, misperceptions and the risk of operational failure. For example, worries have been voiced around Tether, on the basis that it does not provide audited proof that its reserves sufficiently back the coins outstanding.
Stablecoins are likely to become far more prevalent once CBDCs start to be issued and if projects like the Facebook-backed Libra launch.