Limitations of Regular Cryptocurrencies
Cryptocurrencies provide an interesting investment opportunity but have limited potential as a daily-use currency.
With values that fluctuate widely from day-to-day, it is not sensible to use cryptocurrencies like Bitcoin and Litecoin to make basic purchases. No employer would want to pay their employees in an extremely volatile currency as it would be impossible to budget properly, and even worse, there is a high risk that the paid salary would cost more than the value at which the employer purchased the currency.
Price-stable cryptocurrencies are necessary if crypto is to become a significant part of the economy.
The Importance of Stable Value
Stable-value cryptocurrency or “stablecoins” are beginning to make their way to the market. What separates them from traditional crypto coinage is that they are a pegged cryptocurrency. They are tied to an item of established value – in most cases, the U.S. dollar, although gold and silver are also used.
This means stablecoins have a specified and understood value, which allows them to function as part of a reliable economy.
Types of Stablecoins
To better understand how price-stable cryptocurrencies function, it is necessary to review the three major types of stablecoins.
- Fiat-collateral stablecoins are balanced at a 1:1 value as collateral against the asset to which they are pegged. Although this system is stable and supported, it requires an agency that backs the currency and some form of regulation to make sure it maintains its value.
- Crypto-collateral stablecoins work just like fiat-collateral coins, except their value is pegged to a cryptocurrency instead of a real asset. To offset volatility, the coins are usually over capitalized to provide a level stability. Even so, this is still a risky endeavor as a major fluctuation in the pegged cryptocurrency can override the expected stability.
- No-collateral stablecoins are not linked to an asset of any kind. Instead, they maintain their value using smart contracts that increase or decrease the supply of the coin to maintain stability in a decentralized manner.
Major Stablecoin Enterprises
While stable-value cryptocurrency is a relatively new endeavor, a number of stablecoins have already hit the market.
- Basecoin is a no-collateral coin worth 1 USD, stabilized by smart contracts.
- MakerDao has pegged their “Dai” to 1 USD but backed it with Ethereum.
- Tether is a major player in the cryptocurrency world. Their coins are worth 1 USD. For every Tether unit, 1 USD is added to their centrally managed account. This is a strong concept, but in current practice, Tether represents an unlikely long-term bet as it toils amid allegations of corrupt leadership. Many industry experts doubt that Tether’s tokens are fully capitalized to USD in the first place, casting further doubt on the project’s validity. (Also, some people question whether the USD is a good measure of value.)
Conclusion: Stablecoins Have Potential
Regardless of drawbacks, the value proposition of stablecoins, along with privacy coins, remains firm. A trustworthy and open entity that uses this method could capture tomorrow’s crypto market.
For more on cryptocurrency and what makes it reliable, check out What Is Money?