The Missing Piece of the Crypto Puzzle: Inventing a Fair Stablecoin

The Missing Piece of the Crypto Puzzle: Inventing a Fair Stablecoin

May 25, 2021 6 min read

Opinions expressed by Entrepreneur contributors are their own.

When investing in crypto, are a necessary piece of any successful strategy. These are cryptocurrencies pegged to the dollar’s value. However, creating a legally compliant, decentralized and fair stablecoin is more complex than one might think.

Where do millennials invest?

With the Nasdaq, Dow Jones and S&P 500 all hitting all-time highs this month, you wouldn’t believe that we’re living through a pandemic and recession. However, this has everything to do with it. To get out of the Covid-19 economic crisis, governments will have to print money to save struggling sectors. In the face of a falling dollar, investing is more than a nice bonus — it is necessary to preserve wealth. With the Federal Reserve Chairman himself admitting he expects a rise in inflation, a clear message has been sent to everyone — invest your money in anything but a savings account. This message has been heard loud and clear.

Currently, one of the most exciting areas to invest is cryptocurrency. Interest has grown exponentially, leading even the world’s second-richest man, Elon Musk, to invest in Bitcoin. More than a technology, crypto (more precisely, DeFi) aims to challenge the current financial system and recreate it in a fairer, more transparent way.

As prices of real estate rise and commodities such as gold have a hard time keeping up, millennials turn their sights and savings to the fast-growing digital asset class. It’s fun, it’s easy, and it moves quickly. This has led the crypto market to cross the $1 trillion mark at the beginning of 2020. Perhaps even more impressively, the market doubled that a few weeks ago by crossing $2 trillion. The more people believe in it, the faster cryptocurrencies grow.

This has created an increasing demand for a particular type of cryptocurrency, though, one that isn’t likely to grow in value but rather provide utility and stability to the crypto market: stablecoins.

Related: 4 Ways DeFi Can Generate Passive Income

What are stablecoins?

In the simplest terms, stablecoins are cryptocurrencies tied to the value of a currency backed by government regulation and a central bank, such as the U.S. dollar. Very often, this is the currency used by stablecoin providers to guarantee the value of their cryptocurrency. But why would anyone want a cryptocurrency tied to the price of the dollar? Doesn’t that defeat the whole point of investing in cryptocurrencies?

It’s not so simple. While no crypto investor will only hold stablecoins in their portfolio, these have become a vital part of any investment strategy for many reasons. First, they’re an excellent way to transfer a set amount to another person. For example, in the case of a business contract, it’s much easier to agree on a value in dollars than in a volatile cryptocurrency. If you had negotiated a 1BTC monthly salary in March 2020 when Bitcoin traded around $4,000, the contract would undoubtedly pose problems to your employer now that Bitcoin hovers around $50,000.

Second, while the dollar has been on a downward trend in 2021, this decline is slow. By all accounts and purposes, the dollar is a stable currency. This makes stablecoins pegged to their value a good option when it comes to taking profits on successful trades. Often, traders will realize their profits on cryptocurrency trades in stablecoin or predict downturns by converting their crypto assets to stablecoins on crypto exchanges.

The very first stablecoin, Tether, shows why stablecoins can often be problematic. To legally justify their ability to provide stablecoins, Tether declared they would back every single USDT 1:1 with real dollars that could be unlocked if crypto users decided to return their stablecoins. However, this turned out to be false and legal issues followed for Bitfinex, Tether’s parent company.

Related: Tesla CEO Elon Musk Says Bitcoin Purchase is ‘Less Dumb’ Than Holding Cash

A fair and transparent stablecoin

Stablecoins collateralized by real dollars will always be centralized, and this centralization, as was the case for Tether, can lead to abuses. While these are still the most widely used stablecoins, questions about the transparency and credibility of their parent company will always create issues and slow down growth for the crypto market.

On the other hand, stablecoins collateralized by crypto assets such as DAI from MakerDAO allow crypto users to collateralize their digital assets, such as Bitcoin or Ethereum minting DAI, a stablecoin. To regain access to these assets, users have to return the DAI. The problem lies in the fact that if the price of Bitcoin or Ethereum falls and the assets become under-collateralized, the user’s funds can be liquidated and sold to the highest bidder to recuperate its funds.

This also allows investors to increase their leverage. If you were to collateralize Ethereum and borrow DAI, you could use it to buy more Ethereum and increase your exposure. But beware, amplified profits could also lead to amplified losses, and liquidations are a genuine threat in crypto.

The last stablecoin model is the algorithmic one in which stablecoins are not collateralized. These work with a rebase mechanism in which, every 24 hours, the price of the token returns to $1. If there is a lot of demand, new stablecoins are minted and distributed to holders, while if there isn’t enough, the coin returns to $1 and a portion is taken out of circulation.

The stablecoin market is ripe for disruption, and one protocol has an interesting take on a fairer stablecoin. Standard Protocol has developed a model which profits from the strengths of both crypto-collateralized stablecoins and the rebase mechanism to solve the outstanding issues inherent to prior stablecoin models.

First, Standard Protocol is decentralized and its governance is left to its community. This transparency protects it from legal issues and increases the credibility of the protocol. In this protocol, digital assets are collateralized and, if needed, sold fairly through an open automated market maker system that allows anyone to take art in liquidation auctions.

This collateralization of the stablecoin with tangible digital assets will allow Standard’s stablecoin MTR to be more stable than algorithmic stablecoins as the value of each coin will be backed by the user’s assets. These assets could even be natural commodities such as a tokenized representation of gold.

By embracing the elegant but unstable model of algorithmic currencies and backing it with real, valuable assets, Standard Protocol is developing one of the most exciting stablecoin projects so far. This may become the de facto protocol for stablecoin usage in crypto.

Related: Mark Cuban Says Explosive Growth in DeFi Is ‘Like the Early Days of the Internet’

Tether and USDC Hit Milestones as Stablecoin Growth Continues

A lot can be said for stablecoins at the moment, as despite market cap losses, they are still growing. This is demonstrated in particular by Tether (USDT), which has surpassed the $60 billion market capitalization mark. As well as USD Coin (USDC), which sits in the top 10 most valuable cryptocurrencies by market cap in tenth place.

Representatives at Tether confirmed on its official Twitter on May 24 that:

“Tether has just surpassed a $60B market cap! In May 2020, #Tether tokens’ market cap was $8B, now a year on we’ve seen an increase of 581% and demand for Tether token use higher than ever for both trading and retail adoption!”

This new figure ranks USDT as the third most valuable cryptocurrency by market cap, according to data, only behind market frontrunners bitcoin (BTC) and ether (ETH). CoinMarketCap lists USDT’s fellow stablecoin USDC in the top-10. With a current market cap of over $14 billion, USD Coin ranks tenth in the world’s most valuable cryptocurrencies.

The journey up for USDT

The milestone comes just four weeks on from their last, when they went over the $50 billion threshold in April. A week later, on May 4, crypto exchange Coinbase began listing USDT on its platform.

It also comes a week after Tether revealed their initiative to expand beyond the Ethereum blockchain. On May 18, reports stated that USDT would become available on the high-speed Avalanche blockchain. The ninth network option available to traders.

All the same, USDT’s position as the world’s most valuable stablecoin has not been easily won. It has faced doubt from investors, including high-profile players such as Michael Saylor, who dubbed the stablecoin “irrelevant” at the start of the year.

Going even further back, in 2020, USDT was the subject of a class-action lawsuit. The case, on allegations of price manipulation, was denounced by both Tether and its co-accused Bitfinex. The firms eventually settled in February, agreeing to pay an $18 million fine.

Story continues

Stable by name, stable by nature

Both USDT and USDC came out relatively unaffected from the events of May 19, which saw a huge price collapse in several of the world’s leading cryptocurrencies. This is fairly obvious because this is the exact purpose of these types of assets.

USDT’s price zigzagged across both sides of the $1.00 threshold for seven hours but never fell by more than a full $0.01. According to data, from mid-afternoon on May 19, USDT’s price remained consistently above the $1.00 mark ever since. The fluctuation in USDC’s price was similarly mild.

Amid rising stablecoin inflow, cautious traders fear a dead cat bounce

The recent extreme volatility in the cryptocurrency market following Bitcoin’s (BTC) dip to $30,000 and the recovery to $38,000 has traders confused about whether the current price action is a ‘dead cat bounce’ which will see token prices head lower or a solid reversal that will set the floor for the next leg higher for the market.

While BTC price still remains more than 40% below its all-time high of $64,863, bulls have managed to weather multiple attempts to significantly break below support at $36,000.

A closer analysis of on-chain data and exchange inflows shows that Bitcoin’s sell-off led to the market-wide downturn and Delphi Digital analyst Nick Pappageorge highlighted the fact that BTC inflow to exchanges “topped over 20,000 BTC in just one hour on Wednesday,” which was the highest level sesince March 2020.

BTC exchange inflows. Source: Delphi Digital

FUD-o-rama destabilizes the market

One of the major sources of market turbulence identified by Pappageorge was the seemingly daily FUD headlines, including yet another Chinese government ban of cryptocurrencies and concerns that Tesla would dump its Bitcoin holdings. These back-to-back fear-laced narratives led retail traders to offload their coins on exchanges to escape a further price slide.

Pappageorge also pointed to concerns raised by a pair of hacks on the Binance Smart Chain which saw the price of PancakeSwap (CAKE) and Pancake Bunny (BUNNY) plunge, with the latter being drained of $45 million worth of user funds as compounding market fears.

The turnaround in sentiment this week has been in part fueled by positive headlines such as the formation of a Bitcoin mining council following a meeting between Elon Musk, Michael Saylor and North American Bitcoin miners, which has helped spark a turnaround in BTC and altcoins. The quick reversal so triggered the debate on whether the current market activity resembles a dead-cat-bounce or a trend reversal.

70% nuke -> 80% bounce -> 10% dip

Dead Cat or Reversal pic.twitter.com/qefB6y4ahQ — Darren Lau (@Darrenlautf) May 25, 2021

Experienced traders accumulate at lower prices

While many of the newer entrants to the cryptocurrency market have found the recent volatility nauseating, the more experienced investors jumped at the chance to accumulate BTC at a 50% discount as the number of new accumulation addresses reached new all-time highs amid the shakeout.

Number of Bitcoin accumulation addresses. Source: Glassnode

Well-known Twitter personality and Bitcoin analyst PlanB posted the following chart showing how Bitcoin oscillates around the stock-to-flow (S2F) model, showing the recent downturn is well within the standard range it deviates.

BTC price oscillations around S2F model. Source: PlanB

PlanB said:

“Buying opportunities like today are rare (Q1 2019 when I wrote the S2F article, March 2020 due to covid, and now). Life is all about choices.”

As for bullish signs needed to support a quick recovery, the May 24 Delphi Daily report from Ashwath Balakrishnan highlighted the “sharply rising” circulating supply of fiat-backed stablecoins, which has increased from “15 billion to nearly 21 billion in the last 5 days.”

Stablecoin circulating supply. Source: Delphi Digital

While this could be a sign that dip buyers are “loading up ammo,” Balakrishnan was sure to note that “it could also just be stablecoin arbitrageurs” and stressed the importance of “ensuring that the circulating supply doesn’t drop sharply to confirm these inflows will be deployed.”

A record amount of dry powder is now available on exchanges but at the same time, an entirely new cohort of cryptocurrency investors who just experienced their first 50% pullback are now wondering if they should pull out the market or double-down on their investment. The more experienced in the crowd are betting that the market is headed higher but further volatility is all but guaranteed.

The views and opinions expressed here are solely those of the author and do not necessarily reflect the views of Cointelegraph.com. Every investment and trading move involves risk, you should conduct your own research when making a decision.