Migrating Away from Volatile Cryptocurrency—A Case for Stablecoins

Image Source: blog.goodaudience.com

“The problem with fiat money is that it rewards the minority that can handle money, but fools the generation that has worked and saved money.”—Adam Smith

When it comes to money—concepts such as the Federal Reserve Bank, fractional banking, and currency—all come to mind. Clearly there is a lot of misinformation. But let’s face it: We all use it, we all need it, and we all save it— money!

That phrase alone contains a basic economist definition of money and currency.  Money is an instrument that is accepted by all parties to a transaction, that is we agree to use it. We need money as way to pay for food, a mortgage, or the car. And, we use it to pay for a movie, popcorn, and a diet soda. That means, our money must be portable. It has to be easily available. And, we have a need to save money for a rainy day, retirement, or to buy that dream car. In other words, money must have a store of value. Without it, we won’t be able to depend on it for the next week, next year, or 20 years from now.

Indeed, currency and money have been with us for millennia. It’s been said that Jesus asked his followers whose image was on a Roman coin. One answered that Caesar’s image was on the coin. Thus—it was Caesar and the Roman Empire that gave that coin value and sustained it as a legal currency in the Roman Empire.

Image Source: federalreserve.gov – The Federal reserve system.

Today—the world looks to the American dollar as a global standard of value, even though it is no longer pegged to gold. It is fiat currency subject to world currency markets, Federal Reserve interest rates, and other factors that drive the value of dollar. Nonetheless, it is still the global standard.

However, not everyone trusts in the system. Clearly this was the case in 2008, largely in response to the drop in the market, interest rates falling to zero, and the Federal Reserve implementing Quantity Easing to help stimulate the economy.

Following the financial crises a loss of trust in the system ensued. One outcome was a new currency to be free from central banks—Bitcoin. Today there are now hundreds of cryptocurrencies.

After 9 years a newer form of cryptocurrency was introduced, the stablecoin. It was designed to address the issues of high volatility of cryptocurrency. It is pegged to fiat currency or an exchange traded commodity such as gold. (Lexology)  To better understand stablecoin, I start with a review of cryptocurrency.

Cryptocurrency

Rebecca Campbell, writing for The Next Web  summarizes cryptocurrency as decentralized “digital assets that use cryptography as an encryption mechanism for security purposes.”

The goal of Bitcoin was to create a currency independent of central bank control and authority. It was to be a currency that could be digitally transferred with minimal transaction fees and to give monetary control to the people. However, with the volatility of the price of Bitcoin, and reaching nearly $20,000 per coin at its peak—begs the question of whether it indeed has fulfilled its mission.

Campbell notes Bitcoin and other cryptocurrencies use blockchain technology. It provides a permanent record of all transactions, and they are distributed, secure, and immutable. All transactions are confirmed and verified by a network of computers—i.e. nodes—continually updating the blockchain when new blocks of transactions are added. Thus it is the entire network and community that ensures the integrity of the blockchain, and subsequently the value of the cryptocurrency.

Law of Supply and Demand

In my economics classes we had a standing joke: All answers to an econ exam question is “supply and demand”.  How is the value of Bitcoin determined? The answer is supply and demand.

This means that when there is a lot of supply compared to the demand for that coin, the price of that coin will be low. When the demand for a coin, or any commodity is low compared to its supply, the price will also be low. Conversely—when the demand relative to the supply is high, the price will be high. In the case for cryptocurrency, the market cap sets the level of supply.

John P. Kelleher (Investopedia)  state that the current supply of Bitcoin is about 17 million, and is expected to grow to 19 million by 2022. Contrast that with the total global fiat currency supply which is valued at 72.1 trillion USD.

Thus, when we assess the value of Bitcoin, it has a very low level of supply, and an extremely high level of demand creating a price hovering at $10,314 per coin as of this writing. The value is determined as those who trust in the system continue to trust that system. At this time, that system is blockchain and cryptography that is the foundation of the digital coin.

Image Source: manofmany.com – The Demand is there. Bitcoin has a fixed supply of 21 Million which is projected to be mined all mined by the year 2140. Bitcoins mining difficulty changes every 14 days. Imagine a Rubik’s cube and that each time you solved it the cube grew and reset that is how mining is.

 

When looking at other cryptocurrency, we see that most coins are trading at under $1 per coin. Here are Coinbase’s top 5 current prices:

Bitcoin:  $10,314
Bitcoin Cash:  $297
Ethereum:  $178
Litecoin:  $68.74
Zcash:  44.36
Augur:  $10.50
_____________________________________________________________________
Source: Coinbase, 9/13/2019.

Stablecoins

While Bitcoin and most cryptocurrency have wild swings in their prices, the stablecoin is designed to avoid those swings. They are designed to be stable.  According to Cheryl L. Aaron in Lexology,  “a stablecoin is a type of cryptocurrency that is designed to mitigate the short-term volatility that most cryptocurrencies are known for.” As a class of cryptocurrency, stablecoins are pegged to fiat currencies such as the USD, Euro, Swiss Franc, or JPY.

Alternatively, stablecoins may also be pegged to exchange-traded commodities like gold, other cryptocurrencies, or decentralized autonomous organizations. As a result, these alternatives are not as effective at mitigating the volatility they were designed to combat.

Coinsutra  reviewed the best stable coins in the crypto market: Tether, MakerDAO, TrueUSD, Carbon, and Havven. Here are the current prices as of this writing. All trading at or near the value of the USD, except for Carboncoin.

Tether:  $1
MakerDAO (DAI):  $1
TrueUSD:   $1
Carboncoin (Carbon):  $0.000009
Havven:  $0.42
___________________
Source: Coinsutra

Trusted Currency

I started with the story of Caesar’s coinage. In order for an economy and society to be stable, there must be trust in its economic system and in particular its currency. When the price of a currency is volatile, trust is eroded, and that currency will not enjoy wide spread appeal.

The function of the central bank is to create that trust and stability. However, with the complexity of global financial markets, it is not well understood. Thus the demand for something we do understand is created such as transparency of blockchain in cryptocurrency.

“So long as cryptocurrency prices are fluctuating on a daily or even hourly basis, those cryptocurrencies will have a number of impediments to adoption as a traditional currency substitute,” writes Aron.

Stablecoins are pegged to and collateralized by fiat currencies. Because they, seemingly, are not volatile—stablecoins may be a more acceptable medium of exchange and store of value for the general public. They operate like traditional currencies, but with the benefits of “cryptographic security, immutability, accessibility, lower fees, and speedy transactions.”

Conclusion

We all desire to have a better life and to live more comfortably. Clearly, money is what makes the world turn. Currency allows us the ability to exchange a thing of value for products and commodities we want, need, or desire. While cryptocurrency has been around for only 10 years, and stablecoins even less, the cryptocurrency market has created an entire class of citizens forging ahead with this new trading system.

With stablecoins addressing the issues of volatility perhaps we can begin to see a wider acceptance of crypto as a medium of exchange whenever we decide to drop into our favorite coffee shop to buy a cup of coffee with our favorite crypto token.

 

Samuel H. is an author, writer and speaker with over twenty years in the educational technology sector.

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