Stableсoin As The Obsession of Digital Community
CryptoBit News Today3 min read
Although inflation steadily diminishes the value of the dollar, that decline is minor compared to the hyperinflation in countries such as Argentina, Egypt, and Nigeria, where annual inflation can exceed 15%. A stablecoin could provide global access to a currency that's not subject to such drastic price swings, with each token pegged to the U.S. dollar or another stable asset.
The Need for Stablecoins in Crypto
Cryptocurrencies and blockchains can also serve as the foundation for a modern financial network of lending and derivatives markets with fewer inaccuracies and lower fees. These stablecoins could form the backbone of a modern blockchain-based lending and derivatives market. According to the St. Louis Fed, "Price stability means that inflation is sufficiently low and stable so as not to influence the economic decisions of households and firms."
Price deviations and arbitrage opportunities are some of the key challenges facing current stablecoins. Tether, which is pegged to the U.S. dollar, routinely trades between $0.98 and $1.02. An arbitrage profit can become available whenever Tether drifts away from its $1.00 target.
Fiat-Collateralization: Simple, but Not Infallible
The most straightforward way to stabilize a cryptocurrency is through fiat collateralization: units of the stablecoin are directly backed by equivalent units of fiat—like U.S. dollars, so each stablecoin issued has a corresponding dollar in reserve. While the mechanics are relatively simple, fiat-collateralized stablecoins require transparency from the issuer handling custody and reliance on the auditors overseeing the project.
Attention from both the media and the market has centered on counterparty risk, specifically whether issuers actually keep one U.S. dollar in a bank account for each stablecoin in circulation.
Crypto-Collateralization: Replacing Fiat with Cryptocurrency
While fiat-collateralized stablecoins rely on fiat backing, crypto-collateralized ones leverage crypto assets instead. These stablecoins don't directly provide 1 unit of a cryptocurrency per 1 unit of stablecoin—rather, they hold a ratio greater than 1:1, like 150 ETH for every 100 units of Dai, the stablecoin. This massive overcollateralization helps protect against rapid price drops in the crypto market.
Maker is an example of a cryptocurrency-backed stablecoin. The Maker (MKR) token, meanwhile, is a governance token that people creating new DAI must pay a fee in, creating demand. However, the strict collateral requirements could be a major hurdle to the broad adoption of this method.
Algorithmic Models and the Risks of Seigniorage
While both fiat and crypto-collateralized stablecoins rely on holding and managing specific asset ratios, algorithmic stablecoins aim to maintain stable value through a rules-based system of expanding and contracting supply without holding any collateral. The methodology is simple—if the stablecoin value goes above a target price, more stablecoins are issued, and if it goes below, units can be exchanged for bonds to reduce supply.
For Basis, this idea was extended with a multi-token system: The stablecoin itself, along with capitalization shares to receive future issuance. In a seigniorage shares model, when supply shrinks, units can be traded for bonds that are redeemed later if supply expands. The potential for discounted bond purchases was a key feature.
There is a risk that supply will fail to expand, causing units traded for bonds to expire worthless.
The core risk of seigniorage models tied to the U.S. dollar is the risk of bonds expiring worthless after a set period. This showcases the inherent risk presented in models that depend on future growth of demand for stablecoins.
