Here’s how stablecoins work:
The stablecoin issuers hold fiat money with a custodian. Usually it’s U.S. dollars.
They create crypto tokens equivalent to the amount of fiat they’re holding.
They fix the value of one token to the unit of the fiat money, such as U.S. $1.00.
The token itself can be bought or sold on a crypto exchange. As long as it can be redeemed for the fiat currency, it should maintain its value in that currency.
True cryptocurrencies are vastly different because:
Their value is not controlled — directly or indirectly — by any central authority.
They can never be confiscated. Nor do they depend on fiat reserves that could be confiscated.
They carry no counterparty risk. Even if one of the parties goes bankrupt, investors and traders are not left holding the bag.
These unique differences are the main reason cryptocurrencies, no matter how experimental, have attracted so many investors, engineers, mathematicians and speculators. They are the first asset class in history that’s …
purely digital AND
valued completely independently, regardless of any other asset values.
So …
Why are stablecoins needed?
Because, so far at least, the market price of true cryptocurrencies is too volatile. And as long as this continues to be the case, it will be extremely difficult for many distributed applications (dApps) to become mainstream.
Examples abound: Streaming video services. Ride-sharing services. Social media platforms. If their native coins can’t maintain some minimal level of price stability, average users simply won’t risk using them. Speculators may have a love-hate relationship with gyrating cryptos. But someone who’s trying to share a ride? No.
In the interim, Stablecoins offer an immediate, stopgap solution.
They’re a crutch for the dApp folks to lean on until crypto markets mature and stabilize. And that’s not a trivial use-case.
look at what took place recently in Venezuela. Officials of the embattled Maduro government tried to recall their gold reserves held at the Bank of England. But the BOE told them to go fly a kite. “In our book,” they said, “you’re no longer the legitimate rulers.”
We’re not siding with Maduro. But this incident highlights the soft underbelly of custodianship. When you store your assets with a custodian, if push comes to shove in a major crisis, physical possession enables them to take control. And if they cease to recognize your right to the property, you may have to fight it out in the courts or kiss it goodbye.
Ultimately, stablecoins are of the same ilk. They’re only as “stable” as the legacy system they derive their value from. In the long term, only true cryptocurrencies offer the promise of building a more robust, more sustainable structure.