A Brief History of Stablecoins: The Master Key to the Encrypted World

The price of cryptocurrencies fluctuates wildly, leading to the emergence of stablecoins.

Next weekend is your son's birthday. He knows that you have invested in Bitcoin, so he asks you for 1 Bitcoin as a birthday present.

You asked him in surprise:

What?

You want me to give you fifty-three thousand seven hundred dollars for your birthday?

Sixty-two thousand one hundred dollars is a lot of money!

Why do you need seventy-eight thousand four hundred dollars?

What are you doing with the 46,540 yuan? say clearly!

People hope that in the world of crazy inflation, Bitcoin can become our refuge. Bitcoin is not linked to the monetary policy of any country, and people place high hopes on it. However, despite so many expectations, we have to face up to one thing: the world of bitcoin and even cryptocurrencies is still too small, and assets such as bitcoin are far from being widely adopted. One of the main reasons is price fluctuations.

Traditional cryptocurrencies are highly volatile, and it is not uncommon for prices to fluctuate by 10-20% in a day, making them unusable for many people in day-to-day transactions. 2017 was the craziest year for cryptocurrencies, we saw a crazy 10,000x increase, but 2018 wiped everything out. This leads to moments of carnival for a few, but a nightmare for many.

The advantages cryptocurrencies offer certainly cannot be ignored, but wild price swings keep many serious players away. While it's exciting to see an uptrend, not everyone has the investor mindset. Since the regulation in most countries is not friendly to cryptocurrencies, the volatility is driving institutional investors away from cryptocurrencies even more.

Stablecoins emerge

In this context, stablecoins emerged.

store of value

Trading cryptocurrencies is complicated by volatility, making it nearly impossible to trade in exact amounts. The primary task of a stablecoin is to protect the transaction value unchanged. This also makes a strong case for cryptocurrencies and gradually transforms them into full-fledged stores of value.

Can stablecoins be the catalyst for the mass adoption of decentralized financial services? Financial institutions hope to grow stronger with the help of new technologies, while the cryptocurrency community is committed to promoting the popularization of digital currencies. Stablecoins may be a compromise solution.

What stablecoins try to achieve are:

• Perform stable transactions between different cryptocurrency trading pairs, similar to the way of foreign exchange transactions;

• Diversify your portfolio during times of market instability;

• It is hoped that it can be used for daily transactions as easily as using legal currency;

• Promote the popularization of digital currency;

• Form a new financial ecosystem;

• Help with investment planning and minimize current cryptocurrency market volatility;

• Serve as a stable currency used globally to help citizens of countries suffering from hyperinflation.

Although Satoshi Nakamoto's vision for Bitcoin is to use it as electronic cash, Bitcoin, as a cryptocurrency brother, is rarely used in daily transactions. Conversely, high price fluctuations and high fees make many cryptocurrencies unsuitable for day-to-day transactions and more of a long-term investment.

Stablecoins offer all the benefits of cryptocurrencies, including:

• With cryptographic security

• Ability to digitally transfer assets

• Fast and easy transaction

The concept of stablecoins officially appeared in the documents attached to the first version of Mastercoin in 2012. Founder Claims Mastercoin Protocol"Will allow cryptocurrencies to be tied to stable traditional assets."(A brief history of Mastercoin, you can view: blog.omni.foundation)

In July 2014, Realcoin was established and changed its name to Tether on November 20 of the same year. In 2015, Tether Corporation released the first fully realized stablecoin: USDT. USDT is backed by the U.S. dollar and pegged 1:1 to the U.S. dollar. The following year, a similar company in Europe created EURT.

In January 2016, one of Ethereum's code contributors created the stablecoin project DigixDAO.

The most commonly mentioned project, MakerDAO, is one of Ethereum's earliest decentralized autonomous organizations, created in 2014, and Dai is the name of the stablecoin created by the MakerDao project. Three years later, Dai was officially launched in December 2017, and now it has developed into a popular project in the blockchain stablecoin ecosystem.

Of course, more projects such as Libra and JPMorgan Coin are also brewing and developing. In the field of stable currency, it is expected that in 2020, we will see more exciting stories.

Despite the controversy surrounding cryptocurrencies as a medium of exchange, some stablecoins were created in the hope of gaining mainstream acceptance through regulatory approval. For example, the Gemini dollar and Paxos protocols are licensed by the New York State Department of Financial Services (NYDFS).

The issuer of a stablecoin is likely to be obliged to buy back or redeem tokens from holders. If a stabilizer bond represents an obligation of the issuer to the holder, this may constitute a bond type. Therefore, unless proven otherwise, stablecoins are likely to be considered bonds and securities.

Under the framework of the Monetary Authority of Singapore (MAS), stable value assets are considered bonds and issuers are required to hold a Capital Market Services (CMS) license in order to trade in capital market products under the country's Securities and Futures Act (SFA) .

Looking back at the many encounters between Libra and the U.S. Congress, we can also foresee that there are still many legal and regulatory issues that need to be faced and resolved on the way for stablecoins to reach the wider public. This also sets an example for the cryptocurrency community in a broader sense, allowing us to think: what kind of regulation is appropriate for cryptocurrency? What will happen in the future?

Many stablecoin white papers state that their cryptocurrencies are based on"Quantity Theory of Money"Designed to control the money supply in order to maintain price stability.

The mathematical equation in the figure below, is called"Fisher equation". Irving Fisher and Milton Friedman in the 20th century, according to the classical economists of the 17th century"Quantity Theory of Money"The traditional theory developed this equation.

In short, money supply times velocity equals: price level times transaction volume. ( M x V = P x T )

If the value of M doubles, while V and T remain the same, then theoretically P will double; thus, the value of each unit of currency will be cut in half.

Most eminent economists accept"Fisher equation", it is believed that in long-term use,"Fisher equation"It is effective. Therefore, based on classical monetary theory that arose before the 17th century, economists believe that stablecoins will maintain price stability by either increasing or decreasing the money supply.

According to this concept, stablecoins are able to remain stable because if the value of a cryptocurrency drops below a certain price point, its users tend to abandon the cryptocurrency and the total supply of stablecoins decreases, thereby stabilizing its value. If the token's value rises above a certain price point, users add more supply to maintain the cryptocurrency's fair market value.

As an old theory, the quantity theory of money has some problems. An example is that V and T are assumed to be constant in the long run. Therefore, M and P are completely proportional. Due to intelligent design, this theory was developed based on an advanced economic structure, assuming that the velocity of money and transactions will be consistent. However, blockchain projects are changing rapidly and the technology is in its infancy, so it is difficult to calculate token velocity and transaction volume, and it is difficult to assume that they are constant. Considering that V and T are variables, it may be necessary to"Fisher equation"Add more variables to it.

As the name suggests, a stablecoin is a token designed with stability in mind. How is this stability achieved? Different types of stablecoins have different approaches.

While there are dozens of different types of stablecoins in circulation, they all fall into three broad categories: collateralized stablecoins, non-collateralized stablecoins, and hybrids.

Fiat-backed stablecoins

• Fiat-backed stablecoins

Stablecoins backed by legal tender are the most common and simple way to design stablecoins. The value of such stablecoins is tied to reserves of fiat currency.

Tether (USDT) is the first fiat-backed stablecoin. However, since its launch in 2014, Tether has been criticized for failing to produce any audit documents to prove that it has equivalent US dollar reserves. In April 2019, the New York Attorney General launched charges against Tether's parent company, iFinex. It is said that Bitfinex uses Tether's reserves to maintain its own solvency.

Still, the incident did not make Tether lose its dominance as a stablecoin. At the time of writing this report, Tether is ranked fourth on CoinMarketCap. There are many other stablecoins that offer greater transparency. For example, the company TrueUSD has published its audit documents confirming reserves. Paxos Standard and Gemini Dollar are regulated by New York State. USD Coin is also backed by reserves held by financial institutions.

Cryptocurrency-backed stablecoins

• Cryptocurrency-backed stablecoins

A stablecoin that is backed by a cryptocurrency but uses a protocol to ensure that the value does not fluctuate with the price of the token backing the stablecoin. DAI is the most famous example. The DAI token is pegged to the value of the U.S. dollar and backed by ether. The price of DAI is maintained through the Maker smart contract, which creates and destroys MKR tokens based on fluctuations in the price of ETH. Maker launched a multi-currency Dai token, allowing users to back DAI with other types of tokens.

Stablecoins backed by cryptocurrencies have not been as popular as stablecoins backed by fiat assets. Still, there are a few other notable points. With more ETH currently locked in Maker than any other DeFi project, the project is still very popular among believers in decentralization as a way to earn passive income. One concern, however, is that stablecoins could end up becoming under-collateralized if there is a sudden plunge in the market. During the sharp price drop in the crypto market in March, MakerDao also encountered severe challenges.

Asset-backed stablecoins are backed by a reserve of assets other than notes or cryptocurrencies. While this category is relatively new, it has the potential to become very broad. These tokens are not necessarily tied to the price of fiat currencies, but rather to the value of their underlying assets.

For example, Venezuela's famous but failed Petro oil coin project is linked to oil prices. Digix is ​​backed by and pegged to the price of gold. Likewise, Paxos, the issuer of Paxos Standard, offers a gold-backed token called Paxos Gold.

Non-Collateralized Stablecoins

Also known as algorithmic stablecoins, or seigniorage supply coins, these tokens do not have any underlying assets. They are somewhat similar to fiat currencies issued by central banks, whose value increases or decreases according to supply and demand, as a means of dampening volatility. This type of stablecoin is currently not as well known as compared to the other stablecoins mentioned above.

Hybrid Stablecoin

Hybrid Stablecoin

Hybrid stablecoins claim to combine the best features of all stablecoins by providing tokens with a hybrid reserve backing while using algorithms or voting to offset volatility. They are however often structured in rather complex ways.

Boreal, a stablecoin issued by Aurororadao (now IDEX), is an example of a hybrid stablecoin. It is backed by a combination of ETH reserves and loans, and the price is managed by Decentralized Capital, the decentralized bank of the IDEX ecosystem.

Another example is Saga, which is more centralized and also recently launched. It's an ambitious project touted as a rival to Facebook's Libra, whose advisory team includes Nobel Prize-winning economist Myron Scholes. The ERC-20 Saga token is pegged to the IMF’s Special Drawing Rights and will initially be backed by reserves. However, the project expects that over time, the token's value will be determined entirely by the underlying smart contract.

Stablecoins are now very common and can be traded on cryptocurrency exchanges. Naturally, stablecoins hold their value better during periods of volatility in the cryptocurrency market. One example was during the recent cryptocurrency market crash, when many coins fell 30-70%. USDT (Tether), a stablecoin backed by the U.S. dollar, has a volatility of only 8%.

However, there are also some cryptocurrency enthusiasts who think that stablecoins are not cryptocurrencies. Their reasons are:

• Centralized design. Some users are unsure whether binding to the traditional banking system will provide decentralization and anonymity to the owner.

• There is no substantial asset support behind it. Some people think that cryptocurrencies are"counterfeit money", however, after the 1970s, there was actually no asset behind the fiat currency.

• Cryptocurrencies represent unique codes, or digital ledgers, within an unhackable computer network. However, in the stable currency system, adding traditional assets often requires special storage conditions, providing funds for these conditions, and requiring third parties to participate in audits. Again defeats the whole purpose of cryptocurrencies.

Stablecoins and real-world value assets of stablecoins can be used in everyday life; this opens the door for the adoption of cryptocurrencies as a whole.

After most people use digital cash, say in the form of stablecoins, the cryptocurrency community can do a better job of educating people on the benefits of decentralization and the need for trustless cash exchanges. With experience with digital cash, there is less to learn in a new, highly complex, and ever-evolving fintech ecosystem.

All in all, stablecoins could be a key ingredient in a vibrant cryptocurrency future. Advancing mainstream cryptocurrency adoption may require stablecoins as a viable hedging mechanism in highly volatile markets.

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Disclaimer: This article is the author's independent opinion, and does not represent the position of the Blockchain Institute (public account), nor does it constitute any investment opinion or suggestion.

original:https://hackernoon.com/

Disclaimer: This article is the author's independent opinion, and does not represent the position of the Blockchain Institute (public account), nor does it constitute any investment opinion or suggestion.