One of the biggest hurdles facing digital currencies is their extreme volatility. Bitcoin traded near $20,000 in December 2017 only to plummet to around $6,000 two months later — a range of price swings that makes Bitcoin nearly unusable for business owners or consumers. For some, the answer is a stable cryptocurrency, or stablecoin. While the idea isn’t entirely new and the best-known example, Tether, has been trading since 2015, a host of new stablecoins hit the market last year.
1. What are stablecoins?
Digital assets sometimes referred to as coins, sometimes as tokens, that are designed to keep their value. That is, to experience only the milder kind of volatility seen in traditional currencies. Tether, for instance, always trades for about $1.
2. How do they do that?
In one of two ways. Collateralised stablecoins are pegged to another asset, like the U.S. dollar, a basket of national currencies or commodities, and their issuers back up the value of their coin by holding on to that asset. Other stablecoins are pegged to the price of cryptoassets like Ether or a group of digital currencies. Stablecoins of this sort typically employ algorithms to manage supply and demand of the coin so what’s in circulation matches what’s held in reserve.
3. How many stablecoins are there?
As of September 2018, there were 57, of which 23 had been released and 34 were in the planning stages, according to research by Blockchain.com. The stablecoin market value at that time stood at $3 billion, according to the research report.
4. Why are the coins popular?
Stablecoins can be a handy bridge between two worlds that weren’t designed with mixing in mind — cryptocurrencies and traditional finance. That makes them useful as a way to lock in gains from crypto trading or as a safe harbour if investors think a downturn is coming. They also make it easy to transfer funds between crypto exchanges, many of which don’t have the relationships with banks needed to offer fiat deposits or withdrawals. The exchanges can and do accept stablecoins such as Tether, however.
5. What are the different stablecoins like?
Here are some examples:
- By far the most popular stablecoin is Tether, with a $2.6 billion valuation at the time of the Blockchain research report. Tether says that its tokens are backed 1:1 by U.S. dollars. Doubts about that have dogged it for years, and the company has yet to publicly provide conclusive evidence of its holdings. But bank statements from late 2017 to early 2018 seen by Bloomberg News appeared to show a 1-to-1 match between dollars on deposit and the number of tokens issued.
- True USD is another collateraliaed stablecoin that holds greenbacks. When users turn in their True USD for dollars, which are kept in escrow accounts, the stablecoins are destroyed, which helps maintain the 1-to-1 ration with the fiat reserves. Unlike Tether, True USD is releasing monthly reports on its reserves. Yet in May 2018 its price lost the 1-to-1 peg and hit $1.39 in secondary trading after it was announced that the currency would be listed on the cryptoexchange Binance, according to the Blockchain research.
- Dai is a stablecoin pegged to the value of the dollar but backed by Ether, one of the most-valuable cryptocurrencies — yet one that is also wildly volatile like Bitcoin. Dai says that it over-collateralises, that is, it holds more Ether than a 1-to-1 reserve would require, to provide a cushion for swings in Ether’s price. That gives it one of the more complicated price stability mechanisms in the market, as noted in the Blockchain report.
- Gemini Dollar is issued by the digital asset exchange Gemini, founded by Cameron and Tyler Winklevoss. The tokens are also backed by U.S. dollars, which are held by State Street Corp. Its dollar reserves are examined every month by San Francisco-based BPM to ensure they match, according to Tyler Winklevoss.
6. How do stablecoin companies make money?
Interest and fees. The bank statement for Tether reviewed by Bloomberg News showed how much money it was making from the cash pile. It had earned $6.6 million in interest since the beginning of the year, according to the July document. It also charges fees for deposits and withdrawals of fiat money.
7. What’s next?
Stablecoins could be the product that convinces everyday users that cryptocurrencies deserve a place next to their ATM card. In the longer run, if a national government decides to issue its fiat in digital form that would be a big leap for the stablecoin market, assuming the country has a trusted record of maintaining its national currency like the U.S. dollar. While the U.S. doesn’t seem likely to do that soon, the Federal Reserve has been urged to consider the option. The central bank in Sweden, one of the world’s most cashless societies, plans a pilot project with an “e-krona” this year.
8. What are the risks?
That depends on which stablecoin you are talking about. Those tied to digital assets like Ether could crash if it does. Collateralised stablecoins run a risk of fraud, that the reserves they claim are backing the asset are fictional. And like any asset, digital or tangible, there is the risk of secondary-market manipulation which could skew coin values and threaten to break any underlying peg. Lastly, regulators could decide that stablecoins are securities and must be registered in jurisdictions like the U.S. or EU, or be excluded from those markets. In December, Basis, a stablecoin that raised $133 million from investors, said it was closing down the project and returning the money after regulatory guidance it received made it clear it would have to register bonds and token shares as securities under U.S. law.
This article originally appeared on Bloomberg.