The stablecoin market has accelerated over the past year, but much of the crypto world struggles with what they are. Most projects haven't matured past white papers, which doesn't help explain the con
The stablecoin market has accelerated over the past year, but much of the crypto world struggles with what they are. Most projects haven't matured past white papers, which doesn't help explain the concept. This article breaks down how stablecoins work and examines the main projects building them.
**What Stablecoins Are**
A stablecoin is a cryptocurrency designed to resist price swings. Nick Tomaino, founder of 1confirmation, calls it a "cryptocurrency that has price stable characteristics." Haseeb Qureshi refers to them as "price stable cryptocurrencies." Most peg to the US dollar, though some plan to move toward baskets of currencies or the consumer price index, betting on eventual independence from fiat.
Bitcoin and Ethereum are transformative, but their volatility creates problems. Merchants won't accept them, and transaction fees climb higher. Several large companies have abandoned Bitcoin as payment. Stablecoins bypass this friction. They could serve as the foundation for financial applications on blockchains, particularly when compatible with smart contracts. Some venture capitalists and industry figures argue that stablecoins hold more potential than Bitcoin itself, which seems more plausible after understanding what they enable.
The concept has existed for years, but momentum took off in the past year with VC-backed projects like Basecoin and Carbon, along with MakerDAO, which has been in development since 2015. Myles Snider at Multicoin Capital created the Stablecoin Index, tracking over 25 projects at press time. Teams race to build the stablecoin that dominates, and the economic prize is massive. Creating a stable peg requires sound economic design, proper token mechanics, and an initial base of users to sustain the mechanism. Right now traders use them to park capital during downturns, but that represents only a fraction of their potential.
**Why Stablecoins Matter**
Hedging volatility is the main argument. Hold stablecoins instead of Bitcoin or Ethereum and you avoid price swings. Say Bitcoin trades at $8,000. You exchange 1 BTC for a stablecoin pegged to the dollar. You now own $8,000 worth of stablecoins. If Bitcoin falls to $7,000 over the week, your stablecoins hold their $8,000 value and can convert back to BTC anytime. You sidestep the $1,000 loss.
Prediction markets, derivatives, and options all benefit. When you place a long-term bet, denominating it in stablecoins makes more sense than in volatile crypto.
**Three Paths to Stablecoins**
The field divides into three categories: fiat collateralized, crypto collateralized, and non-collateralized. New approaches may emerge as the space develops.
**Fiat Collateralized**
A central entity holds reserves and issues tokens that represent them. It's straightforward. Tether dominates this segment. Its market cap sits at roughly $2.3 billion with daily volume over $1 billion (at press time, $1.4 billion), yet the project has drawn serious fire. Auditor Friedman LLP came under scrutiny. Bitfinex, which shares a CEO with Tether, received a subpoena. Recently, Tether hired Washington firm Freeh Sporkin & Sullivan to audit its accounts, confirming that Tether reserves match circulating tokens.
Tether's market leadership obscures a critical weakness: users must trust a central custodian. Tether's track record troubled many, with accusations of insolvency, price manipulation of Bitcoin, and disputes over previous audits. Those concerns have faded, but they expose why decentralization matters. The main advantage is resilience through market swings, including the crash that followed December's rally. As Haseeb Qureshi points out, fiat-backed stablecoins remain "constrained by legacy payment rails."
TrustToken developed TrueUSD, a dollar-pegged stablecoin, as an answer to Tether's baggage. It addresses trust through transparency mechanisms. The company raised $20 million from a16z crypto, ZhenFund, BlockTower Capital, and others, with public sales on CoinList available to accredited investors. The latest fund attestation is dated July 16th, 2018.
Fiat collateralization may struggle at scale due to capital waste (reserves sitting idle), but these coins continue gaining traction and evolving.
**Crypto Collateralized**
Removing trust requires abandoning central custodians, but a central authority cannot store the capital that a large stablecoin would accumulate, nor can it do so without massive waste. A more distributed path uses crypto reserves instead. Cryptocurrencies are volatile, so this approach demands over-collateralization: users deposit far more value than they receive in stablecoins. This kills the appeal and contradicts any vision of money for the masses.
Nick Tomaino, whose 1confirmation backs MakerDAO, stated that "User control and minimized volatility is a holy grail in not just digital currencies but currencies broadly." MakerDAO, under development since 2015, is complex and difficult to parse. Users deposit crypto into a smart contract and receive stablecoins worth less than the collateral posted. Risk looms large: if collateral drops sharply, the system automatically liquidates the user's position.
**Non-Collateralized**
These stablecoins have no backing asset. Instead they adjust supply based on algorithms responding to price movements. The approach draws from the Quantity Theory of Money, which holds that price levels correspond to the money supply. For coins like Basecoin and Carbon, price above $1 triggers supply expansion. Price below $1 triggers contraction. Both actions create pressure to return the price to the peg.
Basecoin, announced in October, counts Andreessen Horowitz and Metastable Capital as backers. It rebranded to Basis and created a three-token system modeling an algorithmic central bank. When supply needs to contract, the system offers bonds valued at $1 to token holders at a discount. These bonds pay out $1 plus interest down the line. The coins used to buy them are destroyed, shrinking supply. When demand for the coin grows later, the system mints new coins and pays bond holders first. This incentive structure anchors the mechanism. Basis also issued base shares, a fixed-supply token from inception. Holders of base shares receive dividends in newly created basecoins once bonds are repaid and demand continues.
Carbon, a non-collateralized project built by Stanford, Columbia, and Consensys people, runs on Hashgraph and integrates with smart contracts. This matters because as Ethereum-based games exploded, smart contract compatibility could spark a boom in financial apps.
Saga, founded by Nevin Freeman, defies easy categorization. It operates as a non-anonymous stablecoin backed by reserves and using a "variable fractional reserve" of conventional currencies. Money supply adjusts with the size of the Saga economy. SGA tokens will be available Q4 2018 for accredited investors. Saga raised $30 million from Lightspeed, Singulariteam, and Mangrove. Its advisory board includes Jacob Frenkel (chairman of JP Morgan Chase), Emin Gün Sirer (Cornell professor and IC3 director), and Zeev Suraski (early PHP developer).
Reserve, built by Nevin Freeman, closed a $5 million funding round from Coinbase and Peter Thiel. How it rolls out remains unclear, but it warrants close attention.
**Where This Heads**
Stablecoins will transform over time. Venture backing keeps flowing, and strong teams push hard. A single design will come to dominate. For now Tether poses systemic risk and could form a bubble. Crypto-collateralized projects like MakerDAO show technical promise but haven't cracked large-scale adoption. The landscape expanded noticeably in 2017 and builds momentum in 2018, driven by non-collateralized coins that could reshape the space if they achieve their targets.
