There are plenty of misconceptions surrounding stablecoins. One of the main things that I hear frequently is that they will somehow bring the volatility of current crypto markets to heel.
Maybe this is implied by the name, or maybe it's just a misunderstanding of crypto market dynamics when compared to other more traditional financial markets, but stablecoins by themselves won't smooth the turbulent fiat value of crypto assets. Only a massive amount of liquidity in the crypto space and a significant amount of time will do that.
Instead, stablecoins will have a role to play in broadening cryptocurrency markets. In my mind, the most promising and often overlooked application for stablecoins is their utility as on-ramps for assets moving from traditional financial markets into crypto.
I like to use the analogy that if cryptocurrencies are like the Matrix – a digitally-native technology that is completely apart from the physical world – then stablecoins can be like the hard line between these two worlds. In this case, the hard line would exist between the new world of computer-code-based value, e.g. bitcoin, and the traditional value system based on physical assets, e.g. fiat or the U.S. dollar.
Right now, it's hard to get the two worlds to interoperate – there's a lot of needless friction that comes at the costs of time and money. Relying on legacy tools to enter cryptocurrency systems still limits access for billions of unbanked or underbanked people across the globe.
Stablecoins allow people to take advantage of traditional financial tools like access to loans and credit, but also take advantage of things that cryptocurrencies do well, such as sending money quickly and cheaply, creating economies around smart contracts, and powering a slew of decentralized financial applications.
So instead of thinking of stablecoins as some kind of giant ballast that will keep the crypto ship steady, think of them instead as a port – a place for people to load and unload assets.
Emerging models
So far, there are three models emerging as potential methods of creating and managing stablecoins:
Fiat-collateraliteralized stablecoins:These are crypto assets that are held usually in a one-to-one relationship with fiat currency. Tether, the popular and controversial fiat-backed stable coin, is backed by U.S. dollars, for example. So in theory, each tether is a digital representation of a dollar. The peg keeps the price of tether stable, but it comes at a cost – the Tether network must stay centralized to work, and it's got to have a lot of dollars in the bank (at least enough to cover the circulating supply of tether). This creates a scaling issue and a network that requires additional steps like outside audits to make sure the fiat supply is aligned with the tether supply. One big advantage of this style of system, however, is that it's easy to understand because traditional currency markets have also functioned in this floating currency style.
Crypto-collateralized stablecoins:Instead of a fiat peg, these coins are backed by a pool of crypto. Put simply, users stake a certain amount of crypto and then borrow stablecoins against that collateral at a fixed rate. How this process actually unfolds in the background can vary from system to system. The coin known as dai, which is controlled by the decentralized organization Maker, is one example. Another is the recently announced project called Reserve. At Abra, we use a bitcoin- (and litecoin-) based model to collateralize 23 cryptocurrencies and 50 fiat currencies. The challenge with crypto-backed stablecoins is that they can still be vulnerable to the major market shifts of crypto more broadly. Abra manages this risk through an innovative hedging mechanism that virtually eliminates our market exposure to these market shifts. The promise that crypto-collateralized stablecoins hold is that they rely on the same distributed and decentralized architecture that makes cryptocurrencies so novel and resilient.
Algorithmically controlled stablecoins: This is a newer model of stablecoin that constantly adjusts its supply, based on demand, to maintain a constant price. The project Basis is one example. The strength of this method is that it is not trying to be a new version of the fiat reserve system. In fact, there is no collateral at all, which would imply that this model could be scaled. But since there is no collateral, then ultimately the system is built on trust. In the case of Basis, trust is placed in algorithmically controlled software on the network. Time will tell if that trust can be earned or not.
What's next
I also predict that we will see next generation stablecoins that function more like stable assets.
For example, a bitcoin-based share of Apple could allow a consumer to hold Apple stock without the consumer or the broker ever taking possession of an actual Apple share. The amount of bitcoin being held would simply adjust automatically via smart contract to maintain parity with its underlying value versus Apple shares. This opens up the world of decentralized investing via crypto to other non-crypto asset classes. That is a big problem that crypto solves.
Ultimately, I think that stablecoins will play an important role in bridging traditional financial markets with the emerging, programmable financial tools enabled by cryptocurrencies.
Reducing the friction between the crypto and fiat financial systems will help increase access to new kinds of assets and opportunities, which is critical for projects and companies currently building in the crypto space. Stablecoins and stable-assets also represent a tremendous opportunity for people so far left out of crypto to find a viable use case and entry point.
