Any CFD traders active in the crypto sector will know all about the debate raging around the concept of stablecoins. With so many blurred lines and shifting boundaries playing out in the current evolutionary stages of digital tokens, major conceptual arguments such as those surrounding stablecoins go far beyond theoretical discussions and will eventually have far-reaching repercussions on trading environments.
Names such as Tether, TrueUSD and others may or may not be familiar to CFD forex traders but can a digital currency that has a stable value really be called a cyrptocurrency?
Some commentators think that stablecoins are just digital assets which act as a proxy for a named fiat currency. In essence, that is exactly what makes them ‘stable’ but the argument is that it also defeats the original object of Bitcoin and those that followed in its wake, namely to present a radically different way to control and trade funds without having to rely on traditional established fiat money.
How stablecoins work
Juan Villaverde, who leads the Weiss Ratings team of analysts and computer programmers behind the Weiss cryptocurrency ratings, is also a mathematician who has been analysing cryptocurrencies for seven years. Stablecoins work by their issuers holds fiat money as capital with a custodian. Although this usually takes the form of U.S. dollars it could be any recognized established currency.
The crypto token equivalent is then created to match the amount of fiat that has been put aside, and the value of one token is fixed to the unit of the fiat money. The result is that the digital coin can then be traded on a crypto forex exchange and as it could be redeemed for the fiat currency it holds a defined value.
This so-called ‘fungibility’ is been increasingly seen as a valuable development in terms if gaining trust and wider acceptance for cryptocurrencies, but some people such as Villaverde argue that true cryptocurrencies are actually very different for several reasons.
Villaverde says that the value of a true crypto coin is not controlled by any central authority either directly or indirectly. Furthermore they do not depend on fiat reserves that could be confiscated. He also points out that cryptocurrencies are the first asset class in history that is purely digital in form and valued independently from any other asset value.
These unique aspects set them apart and are highly influential factors in their popularity with investors and speculators. So why are stablecoins seen as being needed? Much of the reason for this is because true cryptocurrencies are extremely volatile in terms of price and that has negative effects on the chances of distributed applications (dApps) becoming more mainstream and gaining a bigger profile in terms of public perception.
Speculators and CFD traders may be drawn to the fact that digital coins are subject to wildly changing market conditions, but average users don’t like the risks involved in using them. So many feel that stablecoins offer a stopgap solution for a period in which acceptance is growing but hasn’t yet hit a significant turning point.
What’s the problem?
Villaverde writes: “Here’s the rub: Unlike Bitcoin, Ether and other true cryptos, a stablecoin is more akin to an IOU — a promise to pay another asset in the future — not an asset that holds value on its own merits. If the issuer fails to hold an equivalent value in fiat with a custodian, the whole structure comes unglued.”
In the event of a wide scale disruption to the mainstream global financial system the destabilization involved could bring down stablecoins whose fate is tied to fiat money that could be crashing. This possibilities actually undermines the core concept behind crypto as using currencies based on distributed ledgers are meant to be safe from the possibility of havoc caused by outside forces.
So although stablecoins use the same blockchain ledger tech as other cryptocurrencies they only actually hold a price if a counterparty holds fiat assets in reserve. More than this, that counterparty needs to be willing to redeem the stablecoins for the fiat asset. This adds a whole layer of transactional trust to the process of using the coin or token.
The contradiction involved in this is central to the argument as to whether stable coins can be called true cryptocurrencies. The idea of the distributed ledger is to allow transparency and remove the need to place trust in another party. Also, the very fact that a stablecoin’s value is unable to be separated from that of another asset undermines its own validity as an independent trading asset.
When assets are stored with a custodian they are actually outside of the control of the owner, as in certain circumstances such as a financial crisis access may be denied. This is one of the big attractions for true cryptocurrencies, placing them beyond the reach of centralized control and firmly in the hands of the individual owner to do with them as they please.
Villaverde thinks that stablecoins are only as “stable” as the legacy system they derive their value from. “In the long term, only true cryptocurrencies offer the promise of building a more robust, more sustainable structure,” he concludes.