Do We Need Stablecoins?

Stablecoins have recently become the intellectual and now well funded darling of the cryptocurrency world. Recent startups such as Makerdao, Circle, Basis and Fragments show how hot this space is. Hundreds of millions of dollars have flowed into projects (some little more than white papers) from established venture capital companies. But the question that remains is “Do we really need stablecoins?”

First, what the heck is a stablecoin? In my own words, a stablecoin is a cryptocurrency that attempts to peg or fix a price to an external asset or currency. The most popular stablecoin is currently Tether, which pegs to $1USD. Most stablecoins have similar pegs to EUR, YEN, CNY, or fixed assets such as gold or silver.

So doesn’t this sound wonderful? A stable cryptocurrency? Eureka! I don’t have to worry about losing 20% on BTC over the weekend! Not so fast… first we need to look at why certain fiat currencies are price stable, examine why cryptocurrency is so volatile, and then examine why people buy cryptocurrencies.

Not all fiat currencies are price stable. Although USD, JPY, EUR, etc. are only worth what the next person is willing to pay for it, it’s the implied “trustworthiness” of that country’s government, finances and military that dictate how much it is worth. Hence, USD is considered to be more valuable and stable than the Argentine Peso. In other words, although we can’t quantify all the characteristics that make the USD more “trustworthy” than the Argentine Peso, it’s generally recognized as so.

And so why are cryptocurrencies so volatile? To keep this topic manageable, we are going to use bitcoin (BTC) as a proxy for cryptocurrency. It is the most recognized, widely held and highest market cap crypto currently in circulation. The primary reason why BTC is so volatile? “We” don’t really know what how we’re going to use it.

When I say “we”, I mean the majority of the world. If you’ve made it this far into the article, you represent less than .1% of the world that’s interested in and have an understanding of blockchain technology. I would guess that over 90% of the adult world has a concept of currency and how to use it. Most people think of BTC as a speculative endeavor that will do either one of two things: keep going up forever or crash. The “true believers” in cryptocurrency love the technology behind it and/or the libertarian ideal of moving away from a central bank controlled fiat currency.

But how are we going to use it? Beyond the speculative trading of BTC, we’ve only had two real use cases that I can see. The first involves countries with bank runs (think Greece and Cyprus), hyperinflation (Argentina and Zimbabwe) or a ban on cash (India); basically these situations involve major crises of faith in the sovereign fiat currency.

The second use is one that I can foresee BTC continuing to evolve towards. This is a future in which BTC acts as a store of value but not as a medium of exchange. In other words, think of it like diamonds and gold. If you’re fleeing a country or hoarding wealth, diamonds and gold have an intrinsic value. However, you’re not planning on buying a cup of coffee with a gold coin.

This last usage of BTC as a store of value is still a controversial one. Until BTC (and other cryptocurrences) receive widespread acceptance as a store of value, they will all remain volatile because right now they’re primarily traded as purely speculative instruments.

Achieving price stability happens because a large majority of players understand the currency, why it’s in existence and how it is used. Until we have general consensus on BTC and other cryptocurrencies, natural price stability is far away. Stablecoins answer the question in an artificial way.

Why do I want a cryptocurrency that mimics USD, CNY, EUR, etc.? Besides trading on an exchange, I can’t think of a valid economic reason. I assert that a stablecoin will naturally develop in the market when economic reasons justify it.

Do We Need Stablecoins? was originally published in Data Driven Investor on Medium, where people are continuing the conversation by highlighting and responding to this story.