Stablecoins: The Best of Both Worlds, But Not Without Compromises

Crypto-Collateralized Stablecoins? (Havven as an Example)

Satoshi Nakamoto envisioned that “a purely peer-to-peer version of electronic cash would allow online payments to be sent directly from one party to another without going through a financial institution”, and that is the essence of Bitcoin - decentralized money. However, the fluctuations in price (just yesterday BTC rose from under $7,000 to over $8,000) render Bitcoin ineffective when it comes to a medium of exchange and a store of value.

Ask any business which accepts cryptocurrency payments and you’ll realize how challenging the accounting process becomes when the value of their digital assets is not even remotely stable. Similarly, if a business pays out salaries in crypto, they can’t purely decide upon a BTC figure because one month they could be paying out $20,000 and the next month it could only be $10,000.

While we can’t deny the advantages of digital currencies, particularly their decentralized natures, near instant transactions times, privacy-centric features and seamless cross-border accessibility (regardless of geographical and political boundaries) - at the end of the day most of us turn towards USD, GBP, EUR or other fiat currencies because they are stable.

The question then arises, can we have stable cryptocurrencies or stablecoins?

The notion is very alluring - a digital currency which brings the best of both worlds - but is such a currency even possible? Let’s discuss.

How Do Stablecoins Work?

Simply put, in order for a digital currency to be stable, it needs to be pegged to something (collateralized), and in most cases, these pegs are fiat currencies.

For instance, if an entity decides to issue new tokens which are supposed to be worth a carrot each, the easiest way to ensure that stability is to deposit one carrot for each token released into the market.

While this is not an organic way to move forward, it is an efficient solution which makes sense; however, it is not without its compromises.

USDT as a Fiat-Collateralized Stablecoin

Tether or USDT is a great stablecoin example, backed by USD. According to Tether Limited, each Tether is redeemable for a dollar, which is why you’ll see that its price never fluctuates more than a few cents.

In reality, Tether is just like an IOU, and somewhere, in a bank, controlled by Tether Limited, there should be nearly $2.3 billion, backing each USDT in circulation.

“Should be” is the key term here, because when we’re using USDT, we are effectively trusting Tether Limited to be maintaining the USD peg (unless they are regularly audited - something the company avoids).

Moreover, having the whole collateral held in a fiat currency, in a traditional bank, goes against the principles of decentralization. If anything, the fiat-backed USDT is vulnerable to governmental interference, changing banking laws and financial regulations, and may leave token holders without any recourse in any of the aforementioned events.

Finally, with a stablecoin like USDT, if you wanted to exchange your tokens for cash