As cryptocurrencies like Bitcoin and Ethereum increasingly gain acceptance and popularity, they have inspired a whole new generation of digital tokens that are specially created to maintain their value—neither losing nor gaining it. These so-called stable coins are supposed to eliminate the volatility that has dogged their predecessors for so long and made them a very unattractive wealth storage medium. Ironically this same instability is the reason for the popularity of cryptocurrencies in the first place—their astronomic leaps in value a few years ago easily captured the attention of both the public and the media.
While more stable cryptocurrencies would drive off all the speculators that have so far been one of the biggest driving forces behind the markets for these currencies, these would be more than made up for by ordinary people who would have found an alternative to the electronic money handled by banks and credit card companies that are charged and taxed at every turn. However, most of these stable coin implementations still have a lot of challenges to solve and concerns to address. Most also come with central controlling bodies which violate some of the core tenets behind the creation of cryptocurrencies—decentralised control. These central bodies also operate much like traditional central banks but with far less oversight.
They need yardsticks
To say that a currency maintains its value is not enough because the value is relative. Most of us only realise that money has lost its value after the same amount of money starts buying less in a grocery store. In such a case we would be comparing the value of our money with that of groceries. More usually the value of money is estimated using the amount of foreign currency you can exchange it for. This means that any cryptocurrency that claims to “maintain” value needs to do so against another commodity whose value is already known.
How value is maintained
Once a commodity has been picked whose value a stable coin must be pegged against, a strategy must be introduced to maintain that value in the face of all market forces. This part is one of the most crucial in the implementation of a stable coin, as its failure can turn the coin into an ordinary cryptocurrency subject to the whims of the market.
Stable coins can be backed by exchange-traded commodities such as precious or industrial metals, fiat currencies and even other cryptocurrencies. When a stable coin is backed, the backing asset is the same one which its value is pegged against. For the currency to maintain its value against the backing asset there must be a mechanism for redeeming that asset e.g. a gold-backed cryptocurrency must provide a mechanism for redeeming the gold. Such systems need to centralise the storage and management of said asset and only work when it is managed in good faith and trust is maintained. If these deceptively simple conditions are met, the value of the currency is unlikely to drop below that of its backing asset.
Seignorage-style (Not backed)
These systems do not have any assets backing their value. They use algorithms to maintain their value and they also happen to be the least popular of all stable coin implementations. The algorithms are designed to emulate what many central banks do to manipulate the valuation of their currencies i.e. controlling the money supply. Central banks can lower the value of their money by printing more of it. Raising the value of money then involves doing the opposite of this—destroying it. Sometimes this destruction is quite literal— with physical currency being shredded. Stable coins which use algorithms attempt to digitally replicate these processes ultimately encounter the same challenges that have beleaguered central banks who over-rely on this form of currency manipulation.
Just like their backed counterparts these currencies still need a yardstick against which they must maintain their (initial) value.
These systems can still collapse
Stable coins are still far from immune from market forces. While ordinary currencies adjust their value based on the laws of supply and demand, for stable coins most of the pressure will be felt by the mechanism which maintains their values. If this mechanism is overwhelmed, the currency may implode if there is no intervention. Both backed and un-backed stable coins can be affected.
Backed currencies can, in theory, be wiped out of existence if there is mass redemption of the backing asset(s) due to panic among the holders of the currency or any other reason. The designer of a seignorage-style algorithm is also faced with a dilemma. There will always be a limit to the extent which these algorithms can maintain the value of their currencies. They may come to a point when the algorithm will be forced to choose between allowing the value of the currency to dip (and hence stop being “stable”) or be essentially wiped out of existence.
Some current and proposed stable coins
Digix Gold Tokens (DGX) is an example of a cryptocurrency that is backed by a commodity—in this case, actual gold, which is more than what most countries can say of their national currencies nowadays. The gold is kept in a vault somewhere by the creators of the currency. On the face of it, all this appears to be a technologically superior alternative to buying and keeping gold coins in a safe in your house.
TrueUSD (TUSD) and USD Tether (USDT) are two examples of stable coins which are backed by a fiat currency—in this case, the famously resilient United States dollar. The companies which created and offer these currencies claim that you can redeem the greenback using them.
Recently Facebook has been trying to spearhead the introduction of its cryptocurrency called Libra. Initially, other big companies like Uber, Vodafone, eBay, Mastercard and Paypal were on board but some of these have been pulling out amid public and regulatory uproar. Libra will supposedly be backed by a basket of currencies which include the USD and the Euro.
The decentralised nature of ordinary cryptocurrencies has helped them to dodge regulation in some parts of the world. Stable coins and their creators have more of an uphill struggle as demonstrated by the almost universal backlash against Facebook from the public and the US government for its Libra proposition. If supposedly forward-thinking (in terms of embracing technology) government like the American one is giving Facebook a hard time, I do not see any future for these currencies in countries like Zimbabwe where regulators have already adopted a hard-line stance against more common cryptocurrencies.