Stablecoins have seen explosive growth. A paper published by the European Central Bank (‘ECB’) on 29th August 2019 noted the total market capitalisation of stablecoin initiatives have skyrocketed from €1.5 billion ($1.7 billion) to over €4.3 billion ($4.8 billion) between January 2018 to July 2019.
The same report notes the average volume of stablecoin transactions amounted to €13.5 billion per month between January and July 2019.
What is a stablecoin?
A stablecoin is a cryptocurrency whose value aims to reliably track the value of a real-world asset on a 1-for-1 basis.
Few tracking errors
Stablecoins aim to track real world assets or fiat currencies accurately with the primary objective of having no divergence between the values of the cryptocurrency and its fiat counterpart. The actual tracking must be consistently reliable and therefore stable.
Arbitrage opportunities arise whenever there is divergence between the value of a stablecoin and the value of the real world asset that it is tracking. When this happens, market makers and traders buy or sell the stablecoin to bring its value back into alignment.
Store of value
By design anyone creating a stablecoin will want the cryptocurrency to track a real world asset (or basket of assets) that has historically proven to be a reliable store of value.
For example, the majority of stablecoins track the value of fiat currencies such as USD, EUR, GBP, AUD, JPY, CHF whilst others may track the value of gold or a basket of precious metals. All of these real-world assets have a reliable store of value so when a buyer pays, for example, $1 or £1 for a stablecoin they know that they will eventually be able to redeem it later for $1 or £1.
This is not to say that the currencies of developed nations and gold (or baskets of precious metals) do not fluctuate in value. Quite the contrary, they have on many occasions, although fluctuations are not as volatile as the value of Bitcoin, which has on many circumstances risen or fallen by more than 15% within a 24 hour period.
How do Stablecoins work?
Stablecoins are typically (although not necessarily) pegged to fiat currencies.
Tether, the issuer of the USDT stablecoin, is currently the most traded stablecoin on the market.
Tether claims that every USDT is “always 100% backed by our reserves, which include traditional currency and cash equivalents and, from time to time, may include other assets and receivables from loans made by Tether to third parties, which may include affiliated entities (collectively, “reserves”). Every tether is also 1-to-1 pegged to the dollar, so 1 USD₮ is always valued by Tether at 1 USD.”
How the pegging and mechanisms actually work behind the scenes is unclear and we have not come across any third parties that have audited Tether’s reserves either – at least not that we are currently aware of.
Due to the lack of transparency and auditing verification, regulators are keen to take a closer look. The ECB paper describes stablecoins as “digital units of value that are not a form of any specific currency (or basket thereof) but rather, by relying on a set of stabilisation tools, try to minimise fluctuations in their price in such currencies.“
The full ECB report “In search for stability in crypto assets: are stablecoins the solution?” may be viewed here.
There are many stablecoins on the market. The list we are providing below have high traded volumes.
Dollar pegged stablecoins
Euro pegged stablecoins
British pound pegged stablecoin
Why Are Stablecoins Important?
Stablecoins are primarily used for trading purposes, giving traders the ability to switch their volatile crypto into more stable assets that mimic their home fiat currencies.
So if you’re a trader from the UK, you may prefer to switch your Bitcoin holdings to BGBP as opposed to USDT in order to avoid being exposed to foreign currency risk.
Stablecoins may also be used to conduct low cost international remittances as well as to pay for goods and services, although these use cases are still maturing.