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The rise of regulated stablecoins

In Insights

A stablecoin is a cryptocurrency created to maintain a price that is as stable as possible, usually pegged to the value of a fiat currency.

Stablecoins are highly sought after by traders and exchanges alike — they provide a non-volatile exit option from crypto, just like fiat, but much easier to list from a regulatory and compliance perspective.

Although there is strong demand, the rise of unregulated stablecoins could be seen as bringing unnecessary risk to cryptocurrency markets.

What makes a stablecoin stable

There are a few different ways that stablecoins can become “stable”. The first and most common is a stablecoin back by a physical asset. For every one of the coins issued, the issuing body must have the equivalent amount of the backing asset safely stored.

Most commonly, the collateralized asset is a fiat currency. For fiat-backed stablecoins, every coin issued should in theory have a fiat equivalent backing it.

Stablecoins can also be collateralized with cryptocurrencies, facilitated by smart contracts. In this case, users have to put in more than the stablecoin is actually worth to account for the price volatility of crypto.

Finally, stablecoins can be created using a seigniorage share system, in which an algorithm controls the supply of the coin to maintain the price, selling off coins when the price gets too high, and buying coins or selling shares when the price gets too low.

This can go badly wrong if demand significantly decreases.

The advent of fiat-backed stablecoins

By far the most popular stablecoins are fiat-backed ones. USDT, or Tether, is a stablecoin backed by the USD. Every coin is meant to be worth USD1. Over the past year Tether has experienced massive growth - which in this case refers to the supply, rather than the price. From November 2017 to February 2018, the market cap of USDT increased 390% - from USD240 million to USD2.2 billion.

 

Tether's market cap today of USD2.1 billion is about 1% of the entire crypto sector, which may not seem like a lot, but when you look at volume on a given day, October 17 for example, that USD2.6 billion in volume accounts for about 20% of the entire volume traded that day. If something happens to Tether, the effects are far reaching. It can also be argued that Tether could account for anything up to a quarter of all money ever invested in cryptocurrency, so there is a huge amount riding on this stablecoin remaining stable.

Tether is in control of billions of dollars. As an unregulated stablecoin, critics continue to ask tough questions of Tether. Taking a look at the lifetime Tether graph you can see fluctuations in the price that should, in theory, not happen with a stablecoin.

Weiss Cryptocurrency Ratings wrote an insightful piece about Tether. They discussed how the daily trading volume of Tether regularly exceeds the market cap, which is highly unusual when compared to other cryptocurrencies, especially the major ones. This implies a large portion of the Tether supply changes hands daily. Any problem with Tether is a problem for crypto as a whole.

The need for regulated stablecoins

While tether is the most popular stablecoin, it’s not the only one. Stablecoins can and should be an excellent resource for traders, which is why exchanges have been quick to jump at the chance to list them, especially in absence of having the necessary regulatory approval to list fiat.

The problem begins as dependence on these stablecoins grows. Trading with unregulated stablecoins could be extremely dangerous to crypto as a whole. If unregulated stablecoins fail, the effects can be catastrophic.

The solution may be to embrace regulation. It doesn’t matter whether exchanges do this by listing true fiat currencies or whether they opt to list a regulated stablecoin. The importance is ensuring that we move the market forward to a place where trading volume is sustainable, coming from assets that we know are secure, reliable, regulated and dependable.

Liquid will continue to be a market leader in this respect. We adhere to regulation wherever we operate. Liquid offers multiple true fiat pairings, so traders can enter and exit crypto markets as they wish, without storing their funds in uncertain territory.

We are listing two regulated stablecoins, the Gemini dollar and USD Coin. Every coin we list is thoroughly reviewed by our Legal, Compliance, Trading and Risk teams. We will not expose ourselves or our customers to any potential risks.

The future of cryptocurrency will come from working together with regulators to push the boundaries of what is possible. Unregulated stablecoins are currently bringing uncertainty and risk into the market. It will be better for the market in the long run if we move away from these stablecoins and build a more solid economy.

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This content is not financial advice and should not form the basis of any financial investment decisions nor be seen as a recommendation to buy or sell any good or product. Trading cryptocurrency is complex and comes with a high risk of losing money, particularly if you trade on leverage. You should carefully consider whether trading cryptocurrencies is right for you and take the time to learn how trading works and decide how much money you are prepared to lose.

WRITTEN BY

Liquid

Providing liquidity for the crypto economy.