- The need for a solution for volatile cryptocurrencies
- What are stablecoin and its categories
- Stablecoins applications and limitations
- Long way ahead for stablecoins
In our previous blog related to Blockchain, an emerging concept, a disruptive technology, Televisory discussed on the blockchain’s revolutionary technology, which has the potential to disrupt nearly every industry in the world. The underlying objective of blockchain is to create a new and improved payment system through means of secure currency (cryptocurrencies), which is decentralised, seamless, fast, secure and is universally acceptable. However, a fall in the value of most cryptocurrencies during 2018 raised a concern on their viability and wide acceptability, especially as a currency for goods and services. These virtual currencies were aimed to facilitate more secure and seamless transactions, but their fluctuating prices on a daily basis is fanning flames of speculations and misleading valuations (Read our earlier blog Analysing the price behaviour of the volatile cryptocurrency market). Several investors lost their wealth, who were enjoying a millionaire tag by investing in cryptocurrencies (especially bitcoin) in a matter of weeks, with wide fluctuations and movements seen during the major part of 2018.
Cryptos have been afflicted with high volatility in prices, where 5% or even more than 10% fluctuation in prices on a daily basis is not unusual as seen in the above chart. This is the reason why cryptocurrencies have been criticised for becoming a mean of speculative investments rather than currencies or assets.
This is one of the critical reasons why stablecoins came in the picture. As the name suggests, stablecoins are cryptos which have added benefits of stability, with digital transfer of values. Stablecoins are much more stable and fixed than other cryptocurrencies as they are pegged to other assets or units of value which are globally recognised. These assets or units of value can be US dollar, commodities such as gold, oil, industrial metals, traditional asset class such as cash, bonds or other fiat currencies as well as CDPs (collateralized debt positions) of cryptocurrencies.
In other words, stablecoin comes with benefits of cryptocurrencies; digitisation and fast transactions, transparent, secure, seamless, low fee and maintain privacy without losing stability and trust like other fiat currencies. Stablecoins, which are directly backed by currencies or commodities are referred to as centralised, whereas those leveraging on other cryptocurrencies are said to be decentralised.
Currently, stablecoins have ~$2.75 billion as the total market cap, which is ~2% of the total market cap of all cryptocurrencies (Source: Televisory’s Research). Moreover, they are listed on over 50 exchanges. Tether, the 2nd most active traded cryptocurrency after bitcoin and ranked 7th by market capitalisation is the most popular stablecoin and is used primarily by exchanges as a mean to offer liquidity just like the dollar. It provides a pathway to investors to get rid of inefficiencies due to actual cash out in the real US$ and allow them to convert their holdings into the equivalent of USD.
In a nutshell, volatility has been one of the major hindrances towards universal adoption of cryptocurrencies as a replacement for the fiat or real traditional assets. Stability is key for the mass market adoption and as the cryptocurrency markets continue to oscillate, investors are finding safe haven in stablecoins which is bridging the gap between fiat currencies and cryptocurrencies. Like any other nascent technology, stablecoins also have its pros and cons and require further experimentation and innovation. Stablecoins may prove faulty and struggle with perfect 1:1 parity in the long-run and might not provide an ultimate solution to price volatility in digital currencies due to their scalability and liquidity concerns but still, stablecoins could drive stability within the cryptocurrency ecosystem. It would be too early to say that inchoate stablecoins will become a crucial element in the dynamic cryptocurrency landscape, providing hedging mechanism in this highly volatile digital market as it not only competes with other cryptocurrencies but with fiat currencies alike. Furthermore, like other cryptocurrencies, stablecoins are set to augur a new era of monetary ecosystem and how successfully or unsuccessfully central banks manage their fiats is likely to influence the fate of digital currencies as a whole and their role in the financial system.