Introduction to Phenomenon of Stablecoin Development
The Crypto Chaos
Someone in March 2010 with a username ‘SmokeTooMuch’ auctioned 10,000 bitcoins for $50. Nobody was willing to buy those coins and they had to be given out for free. In 2017 December, 10,000 bitcoins would have been worth about $200 million.
If we were to be candid, it has to be accepted that cryptocurrency did serve as an amazing technology demonstrator for the digital decentralized ledger called the blockchain. However, the volatility of cryptocurrency implies that they cannot be used as an instrument of transaction or compensation.
Just imagine the chaos that ensues if you were to be paid your salary in bitcoin, and you end up paying the entire salary of yours as the house rent because of its value against the dollar, and the very next day, you could have probably bought a snazzy sports car with its current value against the dollar!
There is no question that cryptocurrency has its own share of benefits. It is completely decentralized, and it has the capacity to withstand the economic blows that a fiat currency might suffer.
Ever since the goodness of cryptocurrency was introduced, the proponents of this new technology and financial system have been eyeing a new breed of currency that converges the goodness of cryptocurrency but does not suffer volatility.
… And thus were born stablecoins!
What are stablecoins?
As the name implies, stablecoins are a new breed of cryptocurrency that is immune to price fluctuations… at least considerably. The stabilizing of this fluctuation is achieved by pegging the value of the coin to some asset, either tangible or intangible, but with a solid and globally accepted value.
Let us digress a bit to talk about the concept of pegging. A lot of economic experts would not be fine with the idea of the value of a currency being pegged to an asset.
This is one of the reasons the gold standard was dropped and the price of a currency is determined by, just like for a healthy market, demand, and supply. This has been one of the points of criticism for the stablecoin which we will address later!
Considering the fact that even the most prominent cryptocurrencies like Bitcoin and Ether, have been subject to price fluctuations, stablecoins could be the silver bullet that the crypto world was looking for when it comes to real-world adoption.
This opens up a lot of new opportunities including but not limited to derivatives, prediction markets, loans, and a lot of long terms smart contracts.
Above everything, a stable currency would mean that just like how users keep their money in banks, they can also store their money as a crypto unit that is resistive against fluctuation, and in addition, censorship, currency control, and collapsing economies.
The maintenance of stability
Remember we were talking about the obsolete nature of the concept of pegging? The same economic experts who are against pegging also agree that it is not that difficult to maintain if the market behavior can be determined with a considerable extent of accuracy. It is crucial to determine the band of uncertainty, and how much is too much for the pegging to handle.
The questions that need to be addressed with an uncompromising degree of certainty are the magnitude of volatility the peg can withstand, the cost of maintaining the peg, the possibility of analyzing the band of behavior to determine its recoverability, and the transparency in letting the traders know of the market conditions.
The last two points play a crucial role because pegging a currency is all about cooperation without communication, also known as Schelling point. If the participants of the market cannot collectively identify when a peg is weak, they can become victims of false news that instigates market panic.
Read also: How to Create a Stablecoin on Ethereum
The different types of pegs
As you can infer, the only condition for a stablecoin to be designated is its pegging to some asset with an intrinsic value. Given this parameter, there are different types of stablecoins.
This type is, by a considerable distance, the easiest and simplest of all stablecoins. The value of the coin is literally a dollar and is redeemable for $1. If you would like to liquidate this stablecoin, all you need to do is wire the users the dollars. More than calling it a peg, it can be called a digital representation of a fiat currency.
While this seems quite simple and straightforward on paper, it comes with one of the greatest disadvantages-something that cryptocurrency needs to eliminate. The scheme is highly regulated and the payout can also be an extended and expensive process. It requires centralization and trust on the custodian. Auditing the custodian can be quite an expensive affair. On the flipside, however, that is healthy price robustness. It is immune to crypto volatility in every possible way.
The name seems quite like an oxymoron, doesn’t it? This again seems like a great idea where we keep everything confined to the crypto space without the intervention of any traditional payment elements and centralization. However, the idea falls outside the concept of stability when you collateralize your stablecoin against an unstable asset.
The secret here is to overcollateralize. It should be collateralized to such an extent that the fluctuation can be absorbed without any loss in value. Let us understand this with an example.
If we were to deposit $100 worth Ether against 50 $1 stablecoins against it, it amounts for 200% collateralization. Even if there is a drop in the value of Ether by 25%, the collateralization is still worth 150%. It can now we liquidated and $50 can be issued to the owners. This means that $25 will still remain for the original amount deposited.
The biggest flaw in this entire system is, as you may have guessed, locking up $100 worth Ether for issuing stable coins. However, the flaw is only on the surface.
The issuer can be paid interest, and the extra coins could also be used as a form of leverage. This helps increase the magnitude of profit if the value goes up.
Anything said, it cannot be denied that the price of crypto, however, collateralized or overcollateralized it is, it’s bound to be quality. A lot of purists would call it an unprofitable use of capital. The coin also has a possibility to auto liquidate in the event of a price crash in the underlying crypto collateral.
This is a bigger oxymoron than the previous one! However, come to think of it, a lot of global currencies like the US dollar do not have any collateral. If that model can be adopted by these traditional coins, it could work for the crypto world as well.
It basically models smart contracts to function like a central bank. The only mandate is that the issued currency or in this case, the stablecoin should, without any exceptions, trade at one dollar.
The control of the price is assured by the control in the supply, and consequently, the demand. If the coin trades at a higher price, the smart contract automatically mints new coins bringing down the price. If the coin trades for a price, the smart contract holds or rather buys the coins to arrest the intensity of circulation.
Even this type of stablecoin has its own share of vulnerabilities. If the system cannot violate all the coins, it simply issues shares with an assurance that the value of the coin will grow in the future, making it sound similar to a pyramid scheme. It is very difficult to liquidate and provide cash, and the complexity makes it difficult to analyze the health of the coin.
Related: How to Create Stablecoin?
Which is the most ideal stable coin? This is probably the question that has been intriguing in the minds of every stablecoin developer. Stablecoin development processes have to take into consideration the market dynamics and a multitude of factors that determine the volatility and stability.
It is perhaps the volatility of the entire crypto landscape that makes it an exciting prospect for technology and trading among crypto coins.
However, if cryptocurrency with all its benefits and advantages will have to replace fiat currency, stability is a must. Stablecoin, right now, is looked at as a possible holy grail that both finance and technology are looking for.
If you would like to be one of those aspiring entrepreneurs who would like to spearhead the stable coin revolution, all you need to do is invest in stablecoin development. You can get in touch with a reputed stablecoin developer or a company that specializes in stablecoin development.
They will take care to understand the requirements and give you the technology it needs, for all you know, revolutionize the world of finance forever!
|VanessaJane is a Blockchain Consultant, been in the Software Development Industry for the last 4+ years. She has a great knowledge of Technology, Blockchain, real estate tokenization, Tour and Travels, Fashion, Education, etc also she likes to write about the tips, procedures and everything related to the growth of Business.|