From a technological standpoint and as a medium of exchange digital assets are very innovative but their volatility is not ideal when making payments. By the time a transaction settles, coins can be worth significantly more or less than they were at the time they were sent.
Stablecoins, on the other end, present the main advantage of negligible price movement. They peg their units to the value of fiat currencies or other external references and serve as reliable assets amid volatile markets.
Some of the most common types of stablecoins are:
- Fiat-backed stablecoins
This is the most popular kind of stablecoin that is directly backed by fiat currency, like the dollar or euro, with a 1:1 ratio. A central issuer holds an amount of fiat currency in reserve and issues a proportionate number of tokens. USDT and USDC fall in this category.
- Crypto-backed stablecoins
Crypto-backed stablecoins mirror their fiat-backed counterparts, with the main difference being that cryptocurrency is used as collateral. Smart contracts handle the issuance of units. Monetary policy is determined by voters as part of their governance systems. The most popular example of stablecoin in this category is Dai, backed by ETH.
- Algorithmic stablecoins
Algorithmic stablecoins aren’t backed by fiat or cryptocurrency. Instead, their peg is achieved entirely by algorithms and smart contracts that manage the supply of the tokens issued. Functionally, their monetary policy closely mirrors that used by central banks to manage national currencies.
Stablecoins have had a phenomenal year in 2020
The total stablecoin supply grew from about $5billion to more than $25billion and they represent an important interface between the fiat currency world and the crypto ecosystem.
USDC is one of the more successful stablecoins but it is relatively small compared to its most controversial competitor Tether (USDT), one that is dominating the sector with approximately 80% of market share and a total market cap of $24.4 billion in January 2021.
Nonetheless, many in the industry – and law enforcement – have questioned its legitimacy. Actually, one of the limitations of fiat-backed stablecoins lay within the trust into the centralised exchanges that guarantee the collateral and Tether is currently under investigation in the US.
Trakx, the crypto-index platform, uses USDc as its base trade currency. USDc is a fiat-backed stablecoin issued by regulated financial institutions (Coinbase and Circle). However, not all stablecoins are regulated.
Stablecoins have a big potential for growth
With a huge unbanked and underbanked population globally, and people and businesses looking for faster, easier, and cheaper ways of sending payments across borders, stablecoins have huge potential for growth. Last year has seen a massive acceleration in the digital transformation and payment industry as a result of the pandemic.
In particular, some interesting projects have been noticed and should be followed:
- In the US, early January, the Office of the Comptroller of the Currency (OCC) has announced that national banks and savings associations in the country may use public blockchains and stablecoins for payment activities.
- Libra, now known as Diem, the stablecoin project initiated by Facebook might get off the ground soon, albeit in a more limited format than the original multi-currency basket envisioned. The global stablecoin project was initially proposed to be pegged to a basket composed of multiple fiat currencies but was walked back by project leaders in April 2019 as a result of regulatory pressure from lawmakers in the U.S. and abroad. Diem aims to launch this year.
- Central Bank Digital Currencies, CBDCs (digital representation of Fiat money issued by a Central Bank) are still a relatively new concept but various Central Banks worldwide have started their exploratory and experimental phases. In particular, Central Banks from the Group of Seven nations set out in October 2020 how a digital currency could function. Progress has been slow but should be monitored.
Please contact Laurent at Trakx for additional questions.
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