What Is A Stablecoin?

By Tommy DevoeOn 25 Sep, 2018

A stablecoin is a cryptocurrency that is often pegged to another stable asset, like gold or the US dollar. It’s a currency that is global, but is not closely tied to a central bank and has low volatility. Examine this definition carefully. You can break the definition down to four characteristics – pegged to another asset, global, not closely tied to a central bank, and low volatility. If you are investing in cryptocurrency it is essential to understand the pros and cons associated with stablecoins.

Although I do understand there are a number of additional characteristics, such as: fiat-collateralized vs. crypto-collateralized vs. uncollateralized, I want to focus on the definition. Particularly one aspect of it. In this article, I want to explain why I believe the concept of stablecoins will ultimately not succeed.

Fallacies of Pegging

I think of it this way – an entity has a reserve of an asset, whether that be US dollars, gold or other commodities. They then tokenize that reserve in the form of a stablecoin. Ultimately, that stablecoin is only as volatile as the underlying asset. Therefore, the purpose behind a stablecoin is to make a digital and decentralized representation of an asset of some kind.

Tether, the highest market-cap stablecoin, defines itself as “a digital token backed by fiat currency” in a 1:1 ratio to USD. Claiming that for each Tether coin in circulation, that they hold the USD equivalent in reserve.

I want to stop right there and explain why that one characteristic essentially eliminates another. Being pegged to an asset that is backed by a central bank probably would preclude the claim that there is an advantage of “immunity from legacy banking system problems” (see Tether’s ‘Introduction‘ within whitepaper).

I understand that cryptocurrencies do provide benefits against the banking system. However, inferring that they are immune to the legacy banking system problems is misguided. Stablecoins ultimately create another derivative of the underlying asset. If you want to go down the rabbit hole, having an asset (Stablecoin) that is pegged to another asset (USD, for example) that is ultimately backed by nothing physical – you may find an issue. But that is a whole other topic.

Stablecoins do provide small benefits. Like all cryptocurrencies, it is borderless. It is not under the control of the SWIFT system, which is beneficial for remittances. People claim that it is a way to lock in gains without cashing out of cryptocurrencies. Ultimately, I don’t agree with this statement, as it is often used as a way to try and avoid taxation on capital gains.

In the end, I believe with stablecoins you’re just using a different payment mechanism and custodian for your dollars (particularly in Tether’s case).

Wrapping It All Up

I understand that I have left out some characteristics of stablecoins that differ from Tether. For example, not all stablecoins are pegged to the USD. DAI is a stablecoin that is based pegged to the value of other crypto-assets. However, by being backed by crypto-assets, it all but removes the benefit of stability. Basis is a stablecoin that algorithmically keeps it price at $1. It does this by adjusting its supply to counterbalance demand. However, being pegged to its own supply, and self-admitting that it is a central bank defeats many of the so-called benefits of a stablecoin.

I believe that stablecoins are just a different form of custodial banking and other features of the centralized banking system that already exists. By being pegged to another asset (or nothing at all), these assets ultimately leaves themselves vulnerable to the volatility of the underlying asset itself. It essentially is just adding a second layer to the asset by tokenizing it. I believe the small benefits that stablecoins bring ultimately are outweighed by the misguided concept that stablecoins are immune to central banking and volatility.