The promise of cryptocurrencies was to resolve many of the long-standing issues facing fiat markets—first and foremost, to empower people with more control over their own value and eliminate reliance on centralized governments and financial institutions. Due to globalization and the interconnected nature of trade agreements, the world order can be thrown off-kilter when even a single country experiences turmoil. The entire EU, for example, must deal with the fallout from Brexit and the ambiguity around pre-existing trade agreements. Economic instability within a nation can be devastating with unemployment and economic inequality giving rise to social unrest, riots, and violence. If a currency cannot be trusted to retain its value, people resort to extreme measures. Inflation in Venezuela has prompted a mass exodus of refugees into neighboring countries and has led to a national health crisis, including starvation and increasing cases of malaria.
Currency that doubles as a stable store of value—meaning it does not suffer from volatile fluctuations and does not depreciate over time—can guard against such catastrophic repercussions and form the basis for continued economic growth and prosperity. Unfortunately, no truly stable store of value exists. Despite many attempts made by novel digital currencies to address contemporary economic issues, cryptocurrencies remain incredibly volatile, which poses a giant roadblock to mainstream adoption.
Why volatility is a problem
Whether we are discussing cryptocurrencies or more traditional assets, investors are unlikely to risk placing their capital in anything that is prone to daily fluctuations, or that requires short-term speculation. This is a particular issue for the blockchain industry, as many of these companies hold value in cryptocurrencies, and due to the volatility, cannot ascertain that the value they possess today will be the same value they will possess tomorrow. Unless these projects convert their raises into fiat, which may undercut the vision for utilizing blockchain and tokenization in the first place, they cannot be certain they will retain enough runway to deliver on the promises made during their raise. Furthermore, converting value into fiat is not a sure-fire way to protect it. Even USD, the most stable and predictable fiat currency, depreciates over time. USD lost around 2.1% of its value in 2017 with a cumulative 30-year inflation of 113.07%.
Why stablecoins have fallen short
Stablecoins are intended to offer long-term price stability, achieved through ties to more predictable assets and algorithms. Stablecoins can be broken down into three types: fiat-collateralized, crypto-collateralized, and non-collateralized.
Fiat-collateralized stablecoins are backed by a fiat currency—generally USD, as it remains the most predictable. Some examples include Tether, TrueUSD, and USD Coin. Though fiat-collateralized stablecoins are more stable than most other cryptocurrencies, they will depreciate in value at the same rate as their fiat counterparts and, therefore, do not protect against inflation.
Crypto-collateralized stablecoins do not require centralized intermediaries and so retain more of the spirit of decentralization that inspired the creation of bitcoin back in 2009; however, stablecoins backed by cryptocurrency—even the most trusted, such as Bitcoin or Ethereum—remain extremely volatile. Some examples of crypto-collateralized stablecoins include BitShares, MakerDAO, and Aurora.
The third type of stablecoin, non-collateralized, is not backed by any fiat or crypto asset but attempts to achieve stability through other mechanisms. Basecoin, Carbon, and Kowala are all algorithmic tokens, meaning their value is derived from mathematical formulas. Problematically, many of these non-collateralized stablecoins typically require ever-increasing demand, which is difficult to achieve, complicated in nature to understand, challenging to explain, and even more strenuous to adopt.
Hope for a more stable future
Simply because existing stablecoins have failed to achieve the stability sorely lacking in the crypto economy, doesn’t mean there is no hope. To the contrary, by closely examining what works and what doesn’t, we can create a solution, not just for the crypto economy, but for the economy at large, including fiat markets. An analysis of the pros and cons of three types of stablecoins reveals that an ideal stable currency should be resistant to market volatility, predictable, and easy to understand. In full disclosure, my company Anchor, is developing a solution that takes these factors into account. We have created a new monetary system and financial standard with built-in mechanisms that protect against inflation and volatility to safeguard against the inevitable dynamics of economic uncertainties.
For the stability of our future economy, it is essential to bridge the gap between fiat and crypto markets—to ensure a stable store of value that will guarantee that whatever we earn in our lives does not lose value. And stablecoins have the potential to deliver just that.