Stablecoins have been around for several years now, most prominently in the form of Tether. But what is a stablecoin?
The story behind the stablecoin
Most cryptocurrencies are priced based purely on supply and demand. If more people want to buy than are willing to sell price goes up, and vice versa.
Stablecoins instead are based on a real-world asset and are priced based on that. So Tether, for example, is tethered to the price of the USD. But while it fluctuates slightly around that figure, 1 Tether is always worth $1.
There are other fiat currency backed cryptocurrencies but the principle is always the same. The price of it is always tied to the price of the currency.
An alternative form of stablecoin ties the price of the coins to the price of non-currency assets, like gold. This is based on the model fiat currencies used to be based around in the past. Meaning that the currency being exchangeable for the asset.
Real life stablecoins used to be the norm
In the 20th century, both the UK and the US moved away from asset-backed currencies. This made their currencies true fiat currencies, so stablecoins in this respect are taking an older approach.
All stablecoins have one thing in common, at least in theory. The coins are not minted in the same way Bitcoin is. Instead a stablecoin is issued by a central organisation that hold the real-world asset that they are stable against.
So if there are 59.9 billion Tether issued by Bitfinex, there should be $59.9 billion in their accounts to cover it.
The challenge comes in that this is often not the case. So in the case of Tether in 2019 they announced that each Tether was only backed by $0.74 in cash or cash equivalents. In May 2021 they also released a report that showed only 2.9% of Tether was backed by actual cash.
By this point, however, Tether was widely used and is generally accepted by the community to be traded at $1. Despite these news the price hasn’t dropped much, although it has fluctuated.
So, do we need the stablecoin?
In essence, cryptocurrency markets tend to fluctuate wildly against their fiat price with 10% daily swings not being unusual. A lot of traders want to be able to put their value into something that won’t fluctuate, particularly if the entire market is dropping heavily.
They don’t want to move back into fiat currency either, as in a lot of places this creates a taxable event. Particularly if they are looking to buy back into their crypto of choice soon.
Tether and stablecoins were developed to be a halfway house between crypto and fiat currencies. They offer both the secure trustless advantages of crypto, plus the price stability of fiat money.
They also became an easy means to trade between cryptocurrencies when there was no direct trading pair available. They’re also increasing overall market movements and helping people buy newer cryptocurrencies.
Stablecoins are controversial in the space, due to their centralised nature and questions about their backing. For now though they are here to stay, and perform a very useful role.