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The State of Stablecoins in the Crypto Industry

12 April 2019

 TLDR;

  • Stablecoins are becoming an increasingly important part of the crypto market
  • There are several types of stablecoins that can be launched in either a centralized or decentralized manner
  • The larger number of stablecoins may be driving increased amounts of correlation among top crypto assets
  • Stablecoins are mostly being used for speculation but can also be used to transfer value

 

Over the past year, we have seen stablecoins become an increasingly prominent part of the crypto industry. We have seen numerous stablecoins launched and a greater number of exchanges pairing cryptocurrencies against various stablecoins.

 

The rise of these stablecoins has led to conflicting opinions on what their impact will be on the cryptocurrency market. In this post, we delve into what exactly stablecoins are, the main types of stablecoins, and what the data says about their current role in the market.

 

What is a stablecoin?

 

A stablecoin is a digital asset whose function is to remain pegged to the value of another asset or basket of assets. The most widely used stablecoins by a long stretch are ones pegged to the USD Dollar.

 

Stablecoins have two main use cases:

  • Facilitate speculation
  • Transfer of value

Prior to the propagation of stablecoins, traders typically speculated in altcoins in relation to their price in bitcoin. As exchanges began pairing more and more altcoins with USD-pegged stablecoins, traders were able to speculate in the altcoins in terms of their USD price.

 

A second major use case for stablecoins is the transfer of value. Users can transfer value cross-border at a fraction of the fees it would cost to transfer the underlying fiat currency.

 

The history of stablecoins

 

The leading USD-pegged stablecoins of today are:

USDT was the first major stablecoin to launch. Operating on the Omni Layer, a protocol built on top of Bitcoin, USDT has long been the dominant stablecoin used in the cryptocurrency markets.

 

USDT represents the vast majority of stablecoin trading pairs and has a significantly greater market cap and volume than all competing stablecoins. Its history has been grounded in controversy with numerous allegations made that the firm behind USDT does not hold the necessary USD to hold the value of USDT.

 

As the controversy surrounding USDT continues, several similar stablecoins have launched to challenge USDT with similar ways of maintaining value. Several stablecoins such as the Dai stablecoin of the MakerDAO protocol have launched with vastly different mechanisms for stabilizing value.

 

What types of stablecoins are there?

 

Stablecoins which are launched can adopt either a centralized or a decentralized governance model. Each model offers its own sets of risks and rewards.

 

In the centralized model, one or a small number of entities are responsible for the smooth running of the stablecoin. While this typically maintains a closer peg than the decentralized alternative, it forces the users of the stablecoin to place their trust in the small number of entities.

In the decentralized model, a system of incentives is put in place on a distributed protocol to enable the stablecoin to maintain its value to another asset through actors participating in the system. While this system proposes a solution to the drawback of placing trust in a centralized model, the incentive system can get highly complex and the stablecoins can often struggle to maintain the value of the pegged asset.

 

There are three ways that stablecoins can go about stabilizing their value to another asset:

 

Collateralizing the stablecoin with fiat currency is the main approach used by a stablecoin launched in a centralized way. This typically involves storing the equivalent amount of the asset that the stablecoin is pegged to in a quarterly audited and insured bank account.

 

Dai is the best example of a stablecoin which is collateralized by digital currency. Currently, ether is used as the collateral to stabilize the value but more digital assets are scheduled to be available to be collateralized in the future.

 

Algorithmic stablecoins implement complex algorithmic models to achieve the stabilized value. The most well-known stablecoin system of this category, the Basis protocol, was forced to shut down after meeting regulatory challenges.

 

What does the data say about stablecoins?

 

Tradeblock, an institutional trading tools and research provider, recently released research exploring the data relating to stablecoins. The data indicate that stablecoins are dominantly being used for speculation purposes as opposed to for transfer of value.

 

It did note, that when stablecoins were used for transfer of value purposes, the average transaction value was high with an average transaction of more than $20,000 across top stablecoins.

In line with the crashing prices throughout 2018, the research found that volumes traded with stablecoins also dropped. Trading volumes with major stablecoins decreased from over $20 billion in January of 2018 to less than $5 billion in January of 2019.

 

Research completed by the largest exchange by average trading volume, Binance, reported that the total percentage volume on their exchange from stablecoins increased from 10% to 30% year-on-year.  The Binance research also noted that the propagation of stablecoins may be a driving factor in the high levels of correlation recorded among top cryptocurrencies in terms of USD returns.

 

Proportionally, the TradeBlock research found that stablecoin volumes lost percentage market share in relation to the volumes being traded with the actual US Dollar. Potential reasons noted for this include investors cashing out to cover expenses, pay taxes, or to entirely exiting amid the bear market.

 

Your Stable Takeaways

 

Stablecoins are still at a stage of experimentation and it remains to be seen what the most effective model for launching a stablecoin is. USDT was only launched in 2014 and remains the dominant stablecoin used in the market today with USDC as the most dominant competitor.

Interesting models are being experimented with such as Dai but it is uncertain whether these can stand of the time. The research and data indicate that stablecoins have been having an increasingly important impact on the cryptocurrency market over the past year and may be driving further amounts of altcoin speculation and correlation between major cryptocurrencies.

 

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