This article aims to expound on the benefits of stablecoins and why they remain a vital part of the cryptocurrency ecosystem despite recent events. If you are unfamiliar with stablecoins and how they work, do read our introductory article before reading this.
From shady dealings and concerns around issuers’ balance sheets to recent instances of depegging, stablecoins have been under scrutiny for a while. Although they are designed to maintain a fixed value and are supposed to serve as an anchor of stability amidst the cryptocurrency market turbulence, recent affairs are starting to suggest that stablecoins are far from stable.
Nevertheless, stablecoins constitute a significant slice of the crypto pie, with a combined market capitalization of roughly US$170 billion as of June 2022. They are, undoubtedly, one of the most important products in the crypto space. Their characteristic indifference to market fluctuations as well as settlement assurance on the blockchain has not only made them a key component of the Decentralized Finance (DeFi) financial stack but has also enabled a variety of solutions for the world of legacy systems.
Here are three reasons why stablecoins will not be going anywhere:
1. Stablecoins Are Not Subject to Extreme Price Volatility
In 2010, a man by the name of Laszlo Hanyecz bought two large pizzas for 10,000 Bitcoin (BTC), equivalent to only US$40 at that time. If he had paid with stablecoins and kept his BTC, he would be a multimillionaire today. His mistake is a stark reminder that the volatile nature of cryptocurrencies impedes their use as a viable means of payment. Even companies such as Microsoft and Steam have attempted to accept BTC as a form of payment, which ultimately failed due to the sheer volatility of the asset.
By design, since stablecoins are pegged in value to a real-world currency or commodity such as the US Dollar, they experience minimal price instability as compared to other cryptocurrencies. Thus, they are regarded as a safe haven asset in the crypto market and are seen to fulfill the “currency” aspect of crypto. Cryptocurrencies are typically valued against stablecoins, which function as a unit of account in the crypto market, so traders and investors often use stablecoins as the medium of exchange to purchase and sell crypto.
Moreover, stablecoins offer traders and investors the option of “cashing out” of their crypto positions without converting them back into fiat, thus avoiding the need to interact with traditional banking systems, which might incur significant costs over an extended period of time. However, one should never take a stablecoin’s promise of price stability for granted. In May 2022, Terra USD (UST) saw a catastrophic depegging from the US Dollar. Tether USD (USDT) also lost hold of its dollar peg temporarily, though to a less severe extent than UST, and more recently, the same happened to algorithmic stablecoin Decentralized USD (USDD) which resides on the Tron network. The Terra-LUNA seigniorage mechanism had failed spectacularly in maintaining UST’s dollar peg due to market pressures and internal liquidity issues. The depeg resulted in significant losses across the crypto market, with many losing their life savings. It is always important to do your own research (DYOR) and make sure you know what you are getting into.
2. Stablecoins Enable Frictionless Transactions
Stablecoins are often touted as the best of both the fiat and crypto worlds. They possess the guarantees and stability of fiat while enjoying the immutability and transparency of being blockchain-enabled. Transactions are settled almost instantly and recorded permanently on the digital ledger without relying on third-party intermediaries.
The benefits of stablecoins are evident when juxtaposed against the current state of banking systems and transaction technology, which, due to highly bureaucratic processes, are wrought with inefficiencies and costs. For example, one would normally need to have different bank accounts in different countries in order to transfer fiat funds internationally. Such an encumbrance would be non-existent with the use of stablecoins on a unified blockchain infrastructure, whereby access to liquidity stretches as far as the internet’s reach.
Additionally, the finality of transactions made on the blockchain eliminates the need for some aspects of the traditional process of making cross-border transactions, such as manual verification and custodial services. These are costly in terms of time and money: the simple act of transferring money between loved ones, or carrying out an online purchase, might take days or weeks to complete, while a considerable amount is lost to processing fees. On the other hand, recipients of stablecoins will be able to access their funds more or less immediately, while parties to the transaction can rest easy knowing their payment is assured settlement.
3. Stablecoins Are Seeing Extensive Adoption
Given the benefits of stablecoins, it is no wonder that many applications of stablecoins are being developed as we speak, mostly aimed at revolutionizing traditional payment systems.
Stablecoins see some of its more prominent use cases in remittances. Meta created the Novi Wallet for this purpose and launched it with a pilot program for transferring PAX Dollar (USDP) between users in the US and Guatemala. South Korea’s Shinhan Bank and South Africa’s Standard Bank are each undergoing a proof-of-concept for using stablecoins in cross-border remittances.
With stablecoins, business transactions have become easier, more scalable, and more efficient. Businesses can utilize smart contracts, which are self-executing and enforceable over time, for recurring payments such as loans, subscriptions, and salaries. This is particularly advantageous for global businesses to circumvent the processing fees and time that come with exchanging and transferring fiat in a legacy system. In November 2018, Japanese company Nippon Yusen Kaisha announced plans to develop its own USD-pegged stablecoin to pay workers. Stablecoins are also extensively used in DeFi. Apart from offering the benefit of stability and serving as a reliable means of payment, they are popular assets used to generate yield in DeFi protocols such as Curve. Given that the stablecoins perform their function of upholding consistent value, any yield earned by an investor would be unaffected by crypto market volatility. This ability to ward off impermanent loss serves as a boon for every rational investor.
Are Stablecoins Perfect?
Stablecoins have made a mark on the world, both inside and outside crypto. Apart from the many applications in e-commerce and cross-border transactions, they have earned their place as a fundamental element in crypto portfolios, while their popularity as an asset used to earn yield in DeFi continues to spread like wildfire.
This branch of crypto has been solving a slew of problems and inefficiencies that pervade the world of traditional financial systems, and we have seen a remarkable evolution of stablecoins over the last decade. However, the promise of astronomic returns, combined with an overly-zealous market, has put pressure on the sustainable development of stablecoins, as the space struggles to keep up with the world’s expectations.
Stablecoins, where they stand, are not yet perfect. Gaps in technology aside, there is a long way to go in aligning with the regulatory sphere. Nevertheless, they have the potential to solve a plethora of problems and are redefining the way we invest. As they continue to mature, we must stay grounded with our expectations and bear in mind that no investment in the space is entirely risk-free.