Feature Stories | Aug 04 2021
Stablecoins provide an alternative to highly volatile crypto peers. Central Bank Digital Currencies may nevertheless signal the end of the crypto explosion.
This is the fourth and last article in FNArena’s series on bitcoin and the world of digital money. Links to the first three parts are available below.
-Stablecoins: the answer to crypto volatility?
-Facebook to create a new global reserve currency?
-Central banks fight back
-CBDCs already in use
By Greg Peel
“Cryptocurrencies such as bitcoin and ether offer a number of benefits, and one of the most fundamental is not requiring trust in an intermediary institution to send payments, which opens up their use to anyone around the globe,” notes crypto news and data service CoinDesk. “But one key drawback is that cryptocurrencies’ prices are unpredictable and have a tendency to fluctuate, often wildly”.
Wildly indeed. As we know, bitcoin has seen a rather volatile four years, from US$1000 at the start of 2017 to US$9000 by the end, back to US$3500 by the beginning of 2019, up to US$10,000 mid-2019, down to US$6000 in March 2020 and US$60,000 a year later.
It had “stabilised” recently, if you call call it that, around US$30,000, before a fresh jump to US$40,000.
Such a history rather shatters the prospects of bitcoin as a “store of value” akin to gold, or even as the replacement currency it hopes to be.
As CoinDesk suggests: “This makes them [cryptos] hard for everyday people to use. Generally, people expect to be able to know how much their money will be worth a week from now, both for their security and their livelihood”.
Currency exchange rates and the price of gold do move around, but not to anything like the volatility achieved by cryptos. The average global citizen is unaffected by their relevant exchange rate on a day-to-day basis. The daily rate does not inform as to whether today is a good day to buy a pint of milk, or maybe next week will be better.
Rates will move slowly over time, which ultimately will be evident in the price of imported goods, international holidays and so forth, and in the bigger picture the country’s economic growth. But exchange rates are sufficiently stable as to not to evoke short term angst.
How then, can cryptos become an alternative currency? Pundits argue that volatility will subside over time, as cryptos become more widely used. But there also exists a middle ground.
The Facebook Factor
While a stablecoin is a crypto currency, its value is “pegged” to a more stable asset class, such as a fiat currency (eg US dollar) or the price of gold.
The issuers of stablecoins “back” their currencies with a reserve of said asset acting as collateral. A simple version is to place an amount of US dollars in a US bank. When a holder of stablecoin “token”, as they are known in this instance, cashes in, an equivalent amount is withdrawn from the reserve.
The mere mention of the word “bank” would send a shiver down any crypto purist’s spine. Surely the whole point of crypto-currency is to bypass the legacy financial institutions of this world and their perceived manipulations. But stablecoins still provide the benefit of being a global peer-to-peer exchange system open to all, outside the jurisdiction of said financial institutions.
It’s a trade-off.
It’s a trade-off that Facebook decided to turn to along the rocky road of developing the company’s own crypto-currency.
Facebook first began developing a blockchain and crypto concept in 2017, and in 2018 formally announced the intention to launch “Libra”. The crypto had the support of the likes of PayPal, eBay, Mastercard and Visa.
Facebook is no stranger to regulatory scrutiny. With a focus on anti-competitive, monopolistic actions, regulators were never going to be thrilled about Facebook launching an alternative currency which may one day, given the global popularity of Facebook, threaten the hegemony of the US dollar as global reserve.
In 2019, Facebook announced the currency will not launch until all regulatory concerns have been met and Libra has the "appropriate approvals”. In a meeting with US senators in 2019, Zuckerberg said that Libra would not be launched anywhere in the world without first obtaining approval from United States regulators.
As a result, PayPal, eBay, Mastercard and Visa, along with others, withdrew their support.
In order to overcome regulatory issues, Facebook decided to launch a stablecoin instead. Mercifully, the name was changed to “Diem” from Libra. Diem would be backed by a basket of fiat currencies, including the US dollar and euro, and would be launched in January 2021.
But the market has as yet been unable to carpe Diem. Again, in order to appease US regulators, Diem’s launch has been stalled. Instead, Facebook is now planning to focus on developing multiple stablecoins, each backed by a separate national currency.
As is the case of Ethereum switching from a proof-of-work to a proof-of-stake blockchain model, the launch of Diem remains pending.
But wait, there’s more
Aside from using fiat currencies as collateral, other stablecoins are backed by reserves of precious metals, other cryptos such as ether (how this can be “stable” is unclear) and other types of investment.
On example is “tether”, which started life in 2014 as a one-for-one US dollar-backed stablecoin but this year has disclosed it is now holding almost half its reserves in short term corporate debt, typically described as “commercial paper”. The issuers of that debt have not been disclosed.
Tether is one of the oldest stablecoins and also one of the popular, and thus most valuable by market capitalisation. But if you think it might be handy as an alternative store of wealth, overlooking the commercial paper aspect, tether is used mostly to take advantage of price discrepancies between cryptos listed on different exchanges. In other words arbitrage, which would be something for fast computers, not the man on the street.
And now the founders of Tether are the subject of a US Department of Justice probe into alleged bank fraud. Specifically, federal prosecutors are scrutinising whether Tether concealed from banks that transactions were linked to crypto, back in the early stages of its existence.
Tether has also been used to shift money across borders, in particular to Russia from China, bypassing China’s strict capital controls.
Indeed stablecoins, and cryptos in general, have not proved popular with Beijing.